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Jonathan Gibson

What a year!

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2020 will certainly go down in history as a momentous year, with the tragedy that is Covid-19, the painful global downturn that has ensued, the major curbs on personal freedom and one of the most divisive US elections, carrying the headlines. What will almost certainly be a forgotten as a footnote to the year is the fact that it is looking likely global equities will finish the year slightly up on where they started it.

Yet that is to belie the still raw memory of some of the most severe daily and weekly market falls – and subsequent rapid rises – that investors have ever experienced. Such moments in markets can be disconcerting and, when emotions kick in, can lead to poor decision-making. Being tempted to act on market falls – or the perceived prospect of market falls – is extremely risky and likely to harm your portfolio.

Take a look at the chart below that shows the annual return of developed markets and emerging markets in aggregate (column) and the intra-year fall from that year’s market high (blue dot). 2020 is a good example: the market fell around 25% but is now above its starting point. Likewise, for 2016, which saw an awful start to the year and the Brexit vote, yet the markets ended almost 30% up. Just hanging in there resulted in an annualised return of over 11% over this almost 10-year period, which meant that investors doubled their assets every seven years or so. That is a great outcome.

Figure 1: Responding to market falls is not a good idea

Data source: World equities in GBP 1/2011 to 11/2020. Morningstar Direct © Copyright 2020. All rights reserved.

Actively managed ‘absolute return’ funds, which promise positive returns above cash over two to three-year horizons demonstrate how difficult second-guessing markets is. The recent Financial Times headline ‘Absolute return funds on course for worst ever annual outflows’ says it all. Some funds lost more than 10% this year.

So, when you look back on 2020, just leave your thoughts about the markets in the footnote where it belongs. Many other things were far more important. Let’s hope 2021 brings more joy.

Equity Markets and US Presidents

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When it comes down to the returns of stock markets under different Presidents – Democrat or Republican – does it really matter who is in power?  Should we change our portfolios?  Can we predict what is going to happen?  The quick answers are ‘no’, ‘no’ and ‘no’!

This is perhaps not really very surprising as the price of a company’s shares is based on the future cashflows that it will deliver discounted back to a present value, using a discount rate that reflects the risks associated with that company’s cashflows.  A Presidential term is four years, but a company’s cashflows run into the distant future.  Despite the partisan nature of US politics at this time, Democrats and Republicans are all still capitalists and believe in personal freedom, property rights and, yes – even if it does not feel like it at this moment – democracy.  In a broad political sense, Democrats and Republicans are simply variations on a democratic, capitalist theme.

Active fund managers may try to position portfolios to reflect world events, but predicting the future is very hard to do!  There was much talk of the ‘blue wave trade’ prior to the election to position for a Democrat clean sweep of all parts of government yet look how that seems to be turning out.  A few days ago, the prospect of a vaccine for Covid-19 sent airlines, banks and energy companies soaring and Zoom and other ‘lockdown’ benefiters, such as Ocado, down.

Random events and the release of new information moves the market’s view of cashflows and discount rates resulting in the movement of share prices.  Guessing against randomness is hard but taking on the known risk that equity returns are far less certain than holding cash, rewards investors who ignore this short-term noise and focus on the long-term.

The choice of the US President is important to some, but to the long-term investor it is largely irrelevant from an equity market perspective.

Negative interest rates

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Today, government bond yields and bank deposit rates sit very substantially, and uncomfortably, below where they were 5 and 10 years ago, in negative after-inflation terms and more-or-less-zero before inflation terms.

In March this year, the UK Government issued its first negative-yielding gilt borrowing £3.8 billion at -0.003% for a 3-year maturity.  In other words, they are getting paid to borrow money by investors!  What a strange world we live in today.

Falling yields are evidenced in the range of National Savings & Investments products on offer from the UK government.  The days of Index-linked certificates at RPI + 1%, seem like a distant memory.  The recent slashing of rates across the board on NS&I products leaves savers struggling to cover the erosion of their cash by inflation.

The Bank of England, alongside other central banks, has hinted that negative interest rates remain in its arsenal of tools to help the economy.  Denmark has already seen home loan offers at a negative interest rate, meaning that mortgage borrowers pay back less than they borrow!  One can perhaps see why The Bank of England sees this as a useful stimulant in helping firms and consumers to have the confidence to borrow.  However, if commercial banks are charged for placing deposits with the Bank of England then, in all likelihood, they will pass these costs onto retail depositors.

In effect, negative interest rates represent a transfer from savers to borrowers.  However, there would appear to be limitations to negative rates as banks and individuals might well decide to hold bank notes instead at no cost if negative interest rates persist.

One possible solution is to run a system of dual interest rates[1]. Specifically, this could be targeted at one rate for bank lending (e.g. -1%) and one for bank deposits (e.g. +0.5%).  Various terms and conditions could be applied, such as directing the type of lending the banks could do with this facility.  It has even been suggested that this could be used to drive a new ‘green deal’ where money would be available to companies focused on sustainability.  Borrowers’ net income would rise, as would the benefits of greater economic stimulus through lending to companies to invest in projects.  At the very least, this is an interesting concept.

The one thing that is certain is that it will be extremely hard to preserve the purchasing power of cash in the coming months and possibly years.

At Wells Gibson, our message is clear, having enough cash to meet emergency liquidity needs is important, but make sure that any longer longer-term assets such as your pensions are sensibly invested.

As always please get in contact if you have any questions.

[1]          Eric Lonergan, Megan Greene, 03 September 2020, Dual interest rates give central banks limitless fire power. https://voxeu.org/

Coronavirus and Investing…

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The coronavirus is still very much with us, as is much of the economic dislocation occasioned by the resulting lockdowns.

Granted, we are evidently closing in rapidly on a vaccine, indeed, a number of vaccines.  However, it might be quite some time yet before most of us will get access to a vaccine, and frustration may abound. Furthermore, in the coming weeks we will have to go through a hyper-partisan presidential election in the US, with a variety of voting issues we’ve never had to deal with before.

So, before we’re further engulfed by these multiple unknowns, I want to take a moment to review what we as investors should have learned, or relearned, since the onset of the great market panic that began in February / March and ended when the 500 largest companies in the US, as measured by the S&P 500 Index, regained its pre-crisis highs in mid-August.

The lessons are:

    • No amount of study—of economic commentary and market forecasting—ever prepares us for really dramatic events, which always seem to come at us out of deep left field. Thus, trying to make investment strategy out of so-called “expert” forecasts — much less financial journalism—always sets investors up to fail. Instead, having a long-term Wealth Plan, and working that plan through all the fears (and fads) of an investing lifetime, tends to keep us on the straight and narrow, and helps us to avoid sudden emotional decisions;
    • The global equity market fell 26% in 25 days. None of us have ever seen such a speedy decline before, but with respect to its depth, it was just about average. When reviewing monthly returns data, this ranks 5th in the top declines dating back to 1970.  Declines of -49%, -35%, -33%, -29% have been experienced over that time period.  However, in those ~50 years to 30/09/2020, global equities enjoyed a cumulative return of 12,967% in nominal terms.  The lesson is that, at least historically, the declines haven’t lasted, and long-term progress has reasserted itself;
    • Almost as suddenly as global equities crashed, they completely recovered, surmounting its February 20 all-time high on September 2. Note that the news concerning the virus and the economy continued to be dreadful, even as the market came all the way back. I think there are actually two great lessons here:
    • The speed and trajectory of a major market recovery very often mirror the violence and depth of the preceding decline; and
    • The equity market most often resumes its advance, and may even go into new high ground, considerably before the economic picture clears. If we wait to invest before we see unambiguously favourable economic trends, history tells us that we may have missed a very significant part of the market advance.
    • The overarching lesson of this year’s swift decline and rapid recovery is, of course, that the market can’t be timed, that the long-term, goal-focused equity investor is best advised to just sit tight.

These are the investment policies you and I have been following all along, and if anything, our experience this year has validated this approach even further.

A word now, really just a repetition of what we’ve stressed before, about the US election.  Simply stated, it’s unwise in the extreme to exit global equities in which you’ve been invested during your lifetime because of the uncertainties surrounding the election.  Your chances of getting out the market and then back in advantageously are historically very poor, nor can Wells Gibson possibly help you in attempting to do so.

As we do before every UK or US election, we urge you to just stay the course.  As always, we’re here to talk through these issues with you.


Header photo by Sebastien Gabriel on Unsplash
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Investing Using the Rearview Mirror

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If we could invest by simply looking at what has done well in the recent past – and by that we mean the past few years, not just months – then life would be so much simpler.  Unfortunately, rearview mirror investing is not the best way to build portfolios for the future.

If we take the past three years or so, looking through our rearview mirror, we certainly would not want to have too large a position in the UK or emerging equity markets or global commercial property or value or smaller company shares, which fared poorly on a relative rather than an absolute basis, compared to large companies in overseas developed markets.

Overseas developed markets lagged the broad US market, which in turn lagged growth-oriented shares, particularly technology companies.  In an extreme rear-view mirror scenario, a hindsight investor would invest heavily in US growth shares going forward.  That would be a very concentrated bet and would ignore the fact that all future growth expectations are captured in today’s prices.  These companies need to perform better than these expectations for prices to rise.

At the end of the 2000s the rearview mirror investor would have avoided the broad US and World developed markets, yet in the 2010s they were exceptionally strong performers and emerging markets and value shares suffered relative to the US and the UK was a laggard.  To want to place all your investment eggs in one basket – and in particular the one that has just performed best – seems a little naïve.  No-one knows what the 2020s will bring and diversification is a key tool in mitigating the unknown.

As such, at Wells Gibson we take a highly diversified approach when building our clients’ portfolios.  We also believe that limited exposure to more risky parts of the markets, including companies in emerging countries, smaller companies, and value (relatively cheaper) companies provide the opportunity, although never the guarantee, of delivering returns a little above the broad markets.  It can take some time for them to shine through.  If an extra return were guaranteed, there would be no risk to picking up the return (and it would not exist).

In an environment when cash delivers a negative return after inflation, and the expected returns for both bonds and equities are reduced as a consequence, these incremental returns are not to be sniffed at.  They happen to be all the things that have not done as well (in a relative sense) in the past few years, although they have still delivered strong absolute returns to investors.  Rearview mirror investors would avoid them to their detriment.  More fool them.

Do not look back and wish you had owned a different portfolio but take comfort from the fact that your highly diversified and soundly structured portfolio gives you every chance of a successful outcome in an unknown, forward looking world.

Header photo by Jonny McKenna on Unsplash
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. 
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.