Its Not Harry

Comment and opinion for retail investors in the UK

Markets

Monday mashup – the (US) researchers view of 2021

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I commented in a member only blog post last week that I was little taken aback by the apparent optimism of Morningstar research professionals who presented a view of the US economy’s prospects for 2021. In fairness, they used plenty of supporting data, although of course, no-one has future data! Analysts will be using trend patterns and other statistical methods as well as economic and market theory to extrapolate the future.

Things are looking brighter – or are they?

Here are some extracts from their QI Market Outlook documents that I thought might be of interest. You may raise an eyebrow at one of two predictions!

  • US GDP will rebound by 4.7% in 2021.
  • Vaccine distribution (in the USA) will roll out in the first half of 2021 and be widely distributed by the third quarter.
  • Interest rates (again USA) will stay lower for longer with federal funds rates at 0% until 2024, but longer term rates may drift up this year – a relevant point for fixed income funds with long duration.
  • The huge amounts of corporate debt issued in the USA will slow down as the pandemic ends.

Morningstar’s market valuation standard has the US Equity market 8% over-value, driven by the mega-caps like Apple and Tesla. Tesla and Netflix are unsurprisingly reported to be hugely over-valued (around 150%). Value shares are on the other hand looking to be under-priced, especially at the smaller cap end of the market.

It is anticipated that 2021 will set new records in private equity fund raising.

SPACs (see my separate comments on these funding vehicles in the Watching Brief for January) have raised a large amount of capital which can be geared up to fund plenty of acquisitions (at high prices?).

Oil and energy stocks are the most ‘still’ sold off with the sector down more than 20% over 2020. The analysts expect the global glut of oil to get soaked up and the sector (in the USA) to recover.

All the above suggests a ‘back to normal’ US stock market with reasons to buy into oil and energy companies. That is something you may have noticed in the top 10 holdings of UK recovery and opportunity funds.

The pessimists’ camp – much reported in the UK news media that I see – takes the view that there are many red flags and other behavioural indicators that a market meltdown is more than likely, so making subtle calls on asset classes, stock sectors and so in is a bit irrelevant. This point of view ‘feels’ right to me, but that may be a result of my UK (and thus Brexit influenced) point of view.

Personally, I am 60% or more in the pessimists camp, but less so than I was 6 months ago. I suggest that no-one can know for sure what will happen in 2021 so a carefully balanced mix of good value assets, with diversification across the main classes and prudent use of cash reserves remains appropriate in the near term. If the optimists are right, there will be time to get more money to work in the right assets later in the year.

One theme that is rather more relevant to European than US stocks is ESG. The sustainability theme will be the most important for some years now, in my judgement. So if you want to buy funds, look for value, small cap and sustainability! Europe may well be a better place to start than North America or Asia Pacific. Not quite a needle in a haystack, but a challenge.

Monday mashup – what to say?

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I was of course tempted to put Christmas greeting is the heading and I do of course hope all my readers will have a healthy, peaceful and reflective break.

Some presents may not be getting delivered as planned this year

However, most of you will like me have families and would have been looking forward to seeing children, nieces and nephews, grand children and other family members, and that may not be possible now. The international news this morning is especially gloomy about the Covid-19 situation in the UK with some news media extracting (arguably out of context) the health minister’s phrasing that the situation is ‘out of control’.

Actually Covid infection rates are much worse where I live and the situation is being controlled (hopefully – not much evidence so far) by really tight quarantine measures. They may have been left to the last minute in the UK, but my guess is that the stricter measures are the right action and will need to last a while. At least vaccination programmes are getting under way

In terms of prospects for economies and the long term future of certain types of business, we have serious cause for concern. That is compounded by the approach of January 1st because whatever terms the UK will be applying to trade and other forms of necessary collaboration with mainland Europe after that, there will be more friction.

The news is rarely positive but at the moment it is almost apocalyptic some days

The processes of trade are used to spinning at high speed, like a well oiled machine that never switches off. Any engineer will tell you that even a small increase in friction, or a loss of lubricants, will cause overheating, unpredictable performance and even breakdown of sophisticated machinery.

But, as we know, investment markets and the economy are only connected in a complex and indirect manner, like the weather and the price of your morning coffee.

There are plenty of purely financial reasons for betting on stock markets continuing to rise – accommodative central banks, the rise of SPACs, digital money trends and much more. This I will address in more detail in my comments next month.

So, what to expect? The Spanish Inquisition? But nobody expects the Spanish Inquisition :-). (non-Monty Python fans please indulge my whim!).

My point is that markets are overvalued in many sectors and regions by a large margin on conventional measures, but nonetheless one can still make money riding the momentum.

Such unusual times require a thoughtful and intelligent approach to investing. I hope that in 2021 I can help you follow such a course!

Monday mashup – ‘It’s the economy, stupid’ – except it isn’t

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Economics – the art of educated guesses

The quote in the heading is a well known slogan from Bill Clinton’s campaign strategist James Carville, with the addition of the word ‘it’s’ to what he actually wrote as one of 3 key messages on an office door sign for fellow campaign workers.

I usually recall this quote when reading or hearing economists expounding on the prospects for financial markets by sourcing data and theory from their world. I am a general sceptic of economists, loving the quotation that ‘economists are people who will tell you tomorrow why what they predicted yesterday did NOT happen today’!

I have seen more wrong economic predictions than bad weather forecasts.

I studied some basic economics in my youth and whilst micro economics is a good way of explain aspects to human behaviour, macro economics is more like weather forecasting: immense computer resources are devoted to predicting what will happen in the future, and then a butterfly flaps its wings somewhere in Latin America and it all turns out to be wrong (a premise put forward in an explanation of chaos maths which I once read).

Even ignoring my economist-ism, it is widely understood and very easy to prove that in the near term, investment markets do not in any consistent way perform in line with economies. In some ways, equity and bond markets act as predictors – for example, adjusting in anticipation of prosperous times. At other times, they anticipate recessions, but more often than not a recession has to be proved to be both set in and long term before a raging bull market will correct.

At this very moment, we have august bodies of economists predicting recessions of catastrophic proportions in many global economies, central bankers looking into very empty tool bags and yet many stock markets are at records highs

So is economics useful to investors?

Yes – but not as a basis for deciding what to buy and sell in the short term. We have to remember that the main driver of market prices is supply and demand (some micro economics there) with a good mixing in of human behavioural biases.

Some times and to a greater or lesser extent, macro economic trends that are well set in (like anti-cyclones with the weather) will have an obvious impact on the profitability of companies. If investors can see a major change (eg the reaction to global warming) as being certain to change the way some things will be done (in this case, the slow demise of petrol and diesel cars), they will make investment decisions to try and own shares in those businesses that will profit from such a change.

Note that they will often be wrong, as investors in Clive Sinclair’s C5 must recall, even though he was exactly right in seeing a future for vehicles driven by a big electric motor.

My observation is that the decisions to follow economic trends are driven not by dry data or economists’ modelling, but by an understanding of a well developed story that every one knows. Investors, even the most specialist and experienced are only ordinary human beings like we are and it is a sure thing they have no better knowledge of the future than we do. I appreciate that is a generalisation and some of us, and some specialists, will be a bit more insightful than others.

Big fund managers do employ strategists (a sort of specialist economist). That is like the rulers of old employing soothsayers and magicians. Today they may use computers as opposed to examining the entrails of a sacrificial goat, but I doubt that their success in making predictions is any better.

Economists as social scientists do help us understand how the world works to distribute money and resources and we benefit from that understanding when applying different techniques, mostly to do with the concept of value and risk, when selecting our investments.

Finally, it is only fair to say that some people we know to have been influential economists were, after some practice, great investors – most famously John Maynard Keynes. But some footballers are great golfers, so one has to be careful not to assume a correlation!

Monday mashup – the hokey-cokey

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The title reference is to the ‘in, out, in, out shake it all about’ line in that dance. I am prompted to write about the evergreen conundrum of market timing, mainly as a refresher, for two reasons.

A perpetual question

Firstly, when I am completing the first stage of my training plans with subscribers, they inevitably become nervous when the time comes to actually make purchases from cash reserves. Secondly, the current climate is one where all 3 of the major uncertainties overhanging financial markets for so long are becoming less unpredictable (US elections, Brexit and Covid-19). One might say, one sorted, one soon to be sorted in a way we can predict and the last looking a bit less disastrous.

The second factor suggest it might be a good time to invest but unusually the pricing of large parts of the market suggest there are only 2 games in town: booming new tech growth stocks and dull low value businesses doing old fashioned things. This makes decisions on purchasing far from straightforward without some discipline and methodology.

Resources

I have written on this subject from various viewpoints before. Here are some reference points (several will be subscriber only):

How to time investment sales

Blog post -June 2018

How to pick a fund for the future or how to be a contrarian

A fable for investors

The last article is quite long and I enjoyed writing it, but it may be tricky to follow for some readers. It serves to show that decisions to take money out of markets and re-invest later can be rewarded handsomely but in most cases, the source of the extra profit is luck.

This article can be understood well enough if you skip past my ‘in’ jokes about the financial system in the back story and start reading from the ‘3 decisions’ paragraph.

Some basic common sense

There is good sense in buying obviously cheap markets after a crash and not piling all your free cash into a market that has been booming for years. But aside from those common sense observations, I would suggest the best approach is to think about the long term and have a simple risk minimisation strategy.

Some years ago the then famous fund manager Anthony Bolton (a contrarian manager by style) used to often say that ‘time IN the markets is better than TIMING the markets’. If you look at very long term graphs of stock markets you will see that he is absolutely correct. The line goes steadily up and unless you have a gigantic screen or very large piece of paper, the compression of short term movements means you will not be able to even see the large drop of say October 1987.

Some text book rubrics

Don’t focus on the wrong data – investment is long term

Two things need to always be born in mind:

Every investor, however skilled or experienced buys the right investment at the wrong price when judged over a week or a month, but that might look like a stunning piece of judgement over 5 years or 10 years. In fact, I personally often buy investments I expect to do well a little early and lose money until the market catches up with my analysis. I don’t mind an initial 15% loss if my investment is up 25% in a year’s time – I might have made a lot less if I had waited and the price had already gone up 20% from the low point.

So rule number one it to not get all bitter and regretful about a fall in price in the early weeks or months of a well thought through fund selection.

The second idea to always remember is that when you invest sensibly (ie in diversified and intelligently chosen blocks of shares), you are just jumping on the capitalist machine. It’s function is to make money for investors and over time IT ALWAYS DOES.

Some of us (me included) find the way in which that happens at times rather inconsistent with our personal ethics, but that is really rather irrelevant – the machine exists as a part of the world and without it, the world would not function – even the Chinese communists seem to accept that.

So even if the machine grinds to a halt due to a malfunction from time to time and some people lose faith in it, it gets fixed pretty quickly. One only loses money from a diversified portfolio of collective funds (irrespective of when you bought an investment), if one withdraws money at the wrong time.

So the thing to worry about is managing your cash flow, not when to invest.

If I could ever claim to have been a good IFA, I would like to think it is because I got people to think about objectives first and short term investment returns second. If you have 3 young kids and can only afford one family car, you don’t start your selection process with 0-60 times and top speeds.

We all keep learning

To improve returns, it may arguably make sense to phase investments of larger sums – I accept that. Refer to the various articles listed above for other angles, but don’t expect a neat ‘this is the trick’ answer – it does not exist!

But we can try different techniques and become a little more skilled. We will make mistakes on the way – the world can mess up the most rational decisions. In investment portfolio construction and purchase, the only perfect science is hindsight

Monday mashup – crystal ball gazing? Or forecasting?

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It is easy enough to work out what investors have to worry about at the moment and to give those risks a rating on probability of causing problems – even to guess when the problems will emerge. For example:

  • The US elections – happening very soon and a risk if there is not a clear win for Trump or Biden and Trump refuses to depart even though the polls say he has lost. I don’t think which candidate wins will make much difference on its own to US stock markets, but a constitutional crisis would.
  • Covid 19 – a risk that stock markets are in effect ignoring because many players like the consequent pouring out of nearly free money that is either in effect being invented, or which will be a burden on future tax-payers (which won’t include them, of course!). This Nelson like way of viewing global economics will maybe win a battle, but like Nelson, the corporate warriors won’t be able to avoid a bullet for ever. When it will come is unclear, but I suggest this is a medium term risk.
  • Related to the above is over valuation of shares – the detachment of many companies’ valuations from a logical base and therefore the undermining of many established rules for making sound investments. This looks to me like a repeat of various past periods in recent history. Such bubbles of investment naivety usually burst without much warning. That could be any time soon.
  • And finally for Brits only (and maybe with lesser consequences for Europe) – Brexit. This one has a very easy to observe time scale. We will probably know in less than a month whether or not a deal is really going to happen and even if that is strung out as some suspect. we are going to know by Christmas. The emails I have been getting from the Foreign Office as an EU resident Brit suggest that a least that bit of government is certainly expecting no deal.

None of the above will be new to readers, I am sure, but I find it helps to keep the simple facts in mind when fighting one’s sub-coscious biases, like the Fear of Missing Out (FOMO).

When it stops raining, the sun will come out!

Of course, there are always risks, including ‘Black Swan’ events that might dent our invested wealth and blow our plans off course.

What perhaps is unusual at this time is that it is so easy to see so many risks and know that the market is not properly ‘discounting” them (ie allowing for them in valuations), except perhaps the last one, Brexit.

With the exception of some international mega cap businesses and selected mid and small cap firms, the UK stock market has performed very poorly for some time now. The relative performance of the main UK indices has been awful.

Because the Brexit risk is rapidly coming to a head, one might take the view that whatever happens, the removal of uncertainty and the ‘happening’ of the consequences of Brexit in full in 2021 will make investing in the UK a much more attractive proposition, because whenever there is major change, there are winners as well as losers. We can look for fund managers that we think know how to pick winners in a recovery situation.

I have thought for maybe 2 years that I wanted to participate in this opportunity. I bought UK value (ie out of fashion) and smaller company funds in late 2018 and 2019, thinking that the new Government was going to ‘get Brexit done’. In essence, although I did not wholly trust Boris Johnson, I though his election would unlock the Brexit process. For a while this seemed to have been a good call, but things went pear-shaped.

Even allowing for Covid 19 being a major spanner in the works this year, I was in any case misguided. I have only made money on the smaller companies fund, and given up and sold out of the value funds, because I expected to lose even more money in the near term. I would rather reserve the money in a defensive fund and buy at even cheaper prices. That sort of timing call has risks, of course, which is why I have titled this post as I have done!

I do not think any differently about the consequences of Brexit , only that my timing in buying into the most sensibly valued major stock market in the world was wrong (that happens to all investors sometimes, even the greatest). So I am once again looking for opportunities to buy UK shares at really cheap prices in the near future. I will publish some of my research soon!