Economic insight from a chief investment officer
NOVEMBER 3RD, 2009 By DOMINIC
Well, it’s been another busy week of client meetings and I’m pleased to say I gave a well received presentation to the members of the Altrincham Rotary Club last night. I’m frequently asked questions about the state of our economy and how it will impact on investments. I really felt you’d benefit from some informed comment from Peter Botham, chief investment officer for Brown Shipley. We’ve been using the services of Brown Shipley for a number of years and Peter’s extensive investment experience makes him best place to respond to these commonly asked questions.
Dominic: What kind of recovery do you think we are in for?
Peter: Over zealous enthusiasm of just a few weeks ago has largely disappeared, with economic data from governments as well as companies confirming that we are still in recession and the ‘v’ shaped recovery looks highly unlikely.
For the UK, in particular, there will be a hard slog, with our own economy being one of the worst hit and slowest to recover anywhere in the world. Fortunately, the sharp fall in the value of the Pound will assist the export trade but even an influx of tourists, who find that the UK is a cheap place to go shopping, will not be sufficient to off-set rising unemployment and reduced discretionary expenditure resulting from increased taxation. As investors we should be grateful that over 50% of total earnings for UK companies are derived from outside these shores.
One can see a scenario for the UK where we have a gentle recovery but this then tails off as monetary conditions are tightened in the second half of 2010. This might well entail the end of quantitative easing and a rise in Gilt yields. In essence then, the outlook for UK equities is much better than for Gilts.
Dominic: There has currently been a lot of talk about either high inflation or maybe long term deflation. What is your stance on this issue?
Peter: Whilst there is little inflationary pressure in evidence at the moment, there are several reasons for believing this is only temporary. The mere fact that inflation is a rolling twelve month figure and we are currently at the low point for many input prices is likely to see the figure nudging upwards, particularly in the UK. Also, with Sterling having fallen so sharply in the past year, there is a likelihood that the increased price of imported goods will add a little bit more to the under-current. But, fears of higher inflation around the world are chiefly derived from the possible impact of the vast increase in global liquidity which has occurred in an effort to ensure the continuation of the global banking system. Whilst the impact is minimal whilst banks hold on to this cash as part of their gradual return to solvency, one has to fear that once this recovery has occurred then banks will begin to release these funds in to the economy, and there have been few occasions in history when rising money supply has not led to rising inflation. Index linked bonds in the UK and USA have out-performed conventional government bonds by a wide margin this year, and we see no reason why this should not repeat again in 2010.
Dominic: What advice would you give to any first time investors?
Peter: Arguably the biggest lesson that has been re-emphasised is the importance of diversifying one’s investments.
Investors who relied on equities but believed that having a broad spread of stocks would act as some sort of prop merely discovered that all shares behaved in a similar fashion. One pities the poor (actual!) investor who bought large holdings in all of the UK banks, thinking this would provide diversified security! Taking too much risk without sufficient recognition of the downside possibilities is a recipe for disaster; remember that the investor who loses 50% in the market fall but gains 50% in the recovery is still losing 25%. The risk aware investor who diversified his assets lost 20% in the fall and only gained 20% in the rally – but that means he has only lost 4% at the end of the period.
Dominic: Are emerging markets likely to show more growth than the developed nations over the long term?
Peter: With the balance of economic power set to shift from West to East over the 21st century, one can see that this trend will be reflected in the relative performance of the equity markets. Current valuations between Emerging Markets and developed economies are broadly level but share prices are a function of earnings growth and cash flow (dividend paying) characteristics. Therefore one has to conclude that over the next decade we will see the higher rate of economic growth reflected in above average equity returns. Markets in the Far East, led by China, will continue to prosper but, given the scarcity and dwindling levels of most commodities investors will also see gains from the Latin American and East European nations rich in oil, metals and coal.
Dominic: Finally, the emotive issue of our properties. Do you think we will see another era of house price booms in the near future?
Peter: With the small localised exception of a bonus driven bubble in west London, it is difficult to see how house prices in the UK can do much more than stay level over the next year or so. Bulls point to a scarcity of supply but even for those who wish to jump on the housing ladder, a shortage of mortgage availability is an even more important issue. Unemployment is unlikely to fall by much, if at all, over the next year, which has traditionally had a dampening effect on the housing market. Not only do those without a job stay away from the estate agents but also the many thousands who fear that they could be the next victims of a P45 also do likewise. Perhaps one of the biggest stimulants to housing markets in the UK has occurred when prices are rising strongly, since a bandwagon develops whereby residents become quasi investors and jump on to the wagon for fear of being left behind. Without this price momentum, homeowners can afford to sit tight. For investors, the options in commercial property appear to be much more attractive than in domestic housing. But……..in 3-4 years time there WILL be another bubble. We’ll have worked through the credit crisis, banks will be lending again ( not always wisely ) interest rates at 5% will still make a mortgage very affordable, and the world will once again be gripped by an asset price bubble.
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