Its Not Harry

Comment and opinion for retail investors in the UK

Markets

Dumb and Dumber

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If you stand on a level crossing and you think you can hear a train coming, you might move off. If you can actually see a train coming, you would be a fool not to move off. If you see trains coming from both directions, you need to get moving immediately.

This idea came to me as I read back through my posts of the last 16 months, since the site went live. 2 themes come up again and again: Brexit (of course) and the US President’s enthusiasm for trade tariffs. These are the 2 trains heading inexorably towards our portfolio valuations. For once we might have a market setback with 2 co-incidental causes. Two political choices that may seem pretty dumb with hindsight.

Reader’s know where we are with Brexit. So this time I am passing on that topic. It keeps my blood pressure down.

Time to get out of the way?

This post is intended to draw your attention to the now noted heavy down valuation of the the Chinese currency (renminbi/yuan) against the US dollar. This is the not altogether unexpected way in which they have dealt with US tariffs. They naturally get less dollars for their goods but as they own plenty of US Treasuries (now worth more in local currency) there is at least for them some sure fire hedging.

What this means is that US consumers may not have seen much of a price rise but are just paying more tax (not that they will understand that, I fear). Chinese imports to the US have not fallen, but US exports to China have (now more expensive by a double hit, currency and retaliatory tariffs) and I have read of some severe stress in parts of the US agriculture sector.

That means President Trump may lose votes rather than gain them, but that is not my concern.

This situation has some similarities with the 1997/98 Asian Tiger crash that spread to impact the global economy. In 1994, China devalued heavily to undercut prices in the economies of its Pacific neighbours and that was the key factor in destroying their fragile economies, whose debt was linked to the US dollar. Once their currencies (starting with the Thai Baht) devalued away from the greenback, almighty recessions followed.

There are not exact parallels, but the impact of Chinese goods becoming cheaper will not only be felt in the USA – something I pointed out a long time ago. And more than that – competeing with the Chinese will be more difficult for everyone. That is a parallel.

So, I hear the 2 rumbles that have been building over the last 18 months getting louder. Time to take evasive action? I am.

Boris’s Cummings plan (m)

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When Mrs May was Prime Minister, political sketch writers tended to suggest her Brexit department ministers had no plans and that she just robotically repeating ‘red lines’. In the end civil servants in the UK and the EU came up with a technically sound withdrawal agreement, but as we know a chunk of the Tory party really don’t like it. So as a consequence we have a new Prime Minister.

Is there any hope of a ‘good’ Brexit?

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Boris vs the EU

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The unsurprising election of the new Tory leader and therefore (at least for a while) Prime Minister is bound to be of interest to investors, because it changes the dynamics of the everlasting Brexit saga.

In the short term, any stock market reaction will be ‘false’ because there is no new certainty. In a few weeks, the range of possibilities will narrow down.

The EU wants post Brexit Britain to deal with it in as similar s way as possible as now, because that is in its best interests. Arguably, if free movement was stopped, so would most British people – the sovereignty and common market stuff is less motivating for many, although I do realise not all.

I think the EU will not fall over at any new bravado from the new PM, but may well want to offer him enough concessions to get a deal through Parliament. After all, they are politicians too.

Investors need to pay more attention to what the situation looks like in late September. A no deal exit is without any doubt going to impact UK investment markets like a thunderstorm, if not a tornado. A smooth exit with a managed deal (sort of softish) would see a relief rally.

What do I think will happen? I really have no idea, so am keeping plenty of cash on hand to maximise my options.

‘Buy land – they’re not making it any more!’

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A piece of advice from the ever amusing and perceptive Mark Twain, I believe.

I have recently been looking at model portfolios offered by different investment advisers and funds investing in commercial properties like shopping centres, warehouses and office blocks are pretty much standard components of cautious or defensive models.

When I was in my early 20s and became a pension fund trustee, the pension fund advisers said we needed to buy some property to diversify from our portfolio of fixed income bonds and international equites. I read the proposal and noted that the income yield was about 4.5%. As other fixed income assets were paying about twice that, I could not see the advantages.

What was politely explained to me was that inflation in the early 1980’s was so high that the return on deposits and government bonds was in real terms negative. Because property values went up with inflation, so did the rent over time (unless you had no tenant, of course) and that was the merit of the asset. It was a hedge against inflation.

That is the main theoretical advantage of owning a portfolio of commercial properties. Commercial property has the advantage over private residential property in that the owner has much stronger rights over the tenant and rarely has to meet the cost of repairs, insurance and so on. Leases are also quite long, typically 9 years at least and sometimes much longer. Tenants may be ultra reliable, like banks or government departments.

All asset classes should be bought in the context of the value on offer at the time of purchase.

So financial advisers put property funds in portfolios to get the steady income yield, the inflation proofing over time and there is also a limited degree of diversification.

But, that does not mean they are ‘safe as houses’. Commercial properties do not sell quickly, so such funds have to hold a lot of cash to meet withdrawal requests when people get nervous, or they have to impose restrictions on withdrawals. Holding cash when cash interest rates are low is a drag on performance.

Valuations are also not so frequent, maybe quarterly. And valuation is a matter of opinion if the property is not actually for sale. Comparisons with similar properties are made, so if the market gets into trouble there is contagion.

If valuations go up over a long period and economic factors mean that rents don’t, then yields are said to become ‘compressed’. That is usually a warning that valuations need to come down, because the asset class is becoming less attractive. I have seen that happen several times in my working life – there is a definite cycle.

Tax is an issue too as property fund income is taxable at source unless it is set up as a PAIF (a special type of fund structure) and that is not possible with conventional collective funds, only ISAS, SIPPS and other tax exempt structures. So non-taxpayers will lose 20% of their yield in some cases. After tax and expenses, some well known retail property funds are currently yielding not much over 2%.

With town centre retailers having a hard time, Brexit threatening distribution chains and foreigners not wanting to invest in Britain, the sector faces some tough headwinds. I would be avoiding it for the time being, but will always consider it as a portfolio component when the time is right.

Most investors in Southern England already own plenty of land (in value terms) and live on it!