Its Not Harry

Comment and opinion for retail investors in the UK

Markets

Boris vs the EU

by Leave a Comment

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!’

by Leave a Comment

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!

Slack, bang, wallop?

by Leave a Comment

Another astonishing new share flotation in the US. A business messaging application called Slack (hardly a great novelty – I can recall various versions of such going back 20 years) has floated and immediately moved to a valuation, based on share price of 25 billion dollars.

This is a business that turns over 400 million dollars and managed to lose more money than its previous year’s turnover. As the BBC explainer on this says, losing money when you start a business is normal (easier when it is someone else’s money, I might add). The BBC refers to the few successes that became worth billions, but in recent examples the valuation is starting at billions, in effect completely discounting any chance to make money like that in the future. The sure fire winners are the founders, who have struck lucky.

The valuation is clearly totally detached from reality and the only other people who will make money are those who resell their initial allocation of shares to those who haven’t got them and want to speculate, at a nice profit. These people only invested to make this resell profit, like ticket touts. They don’t care in the slightest if the underlying business is any good any more than a ticket tout has any interest in the singing merits of Taylor Swift.

At its worst, the stock market makes gambling look logical

This sort of activity has not much direct relevance for investors in retail funds, but when it becomes the norm, one must worry. Why? Because if 25 billion dollars goes into a worthless business and is later lost, the investors in question will sell other assets to balance their books and those sort of sales have a significant negative effect on the market.

And that is not all – a crash in a certain segment of the market can be the start of a domino effect, because the market mood changes and FOMO (fear of missing out) is substituted by a rush for the emergency exits.

If you have big profits in tech funds, now might be the time to think about securing them!

When ‘insurance’ maybe doesn’t pay out.

by Leave a Comment

I read today on the Bloomberg new service that the yield on US Treasuries (which is a quick way of summarising the price of US Government bonds) has fallen to a level that implies the US Federal reserve will CUT interest rates 3 times next year. That is not altogether what one might predict!

It seems that worries about trade wars and other factors are prompting big players to buy Treasuries, either to profit from such rate cuts, or because they think there will be a US recession, or both. Apparently there is a strong view that such a recession is on the way. If there is and bank rates fall then the ‘hedge’ might work and provide some compensation when equity prices collapse.

But the idea of a US recession is hardly good news. Much as we don’t rejoice in making an insurance claim when some disaster happens, we are unlikely to be happy to make a bit on our exposure to the US bond market if we are seeing our equity portfolios trashed.

The world economies are not all moving in synch …

What if US interest rates don’t fall? With very high employment levels and Trump’s tariffs likely to push up inflation, then there is some probability that they won’t. They may even go up more. In that case, the yield on Treasuries will need to rise and values will fall. That may also be bad news for equity markets and furthermore at some stage a recession will happen. So there could be a double whammy.

In that case investors will have to ponder the storm damage and realise that the insurance is not going to help.

I take the view that as political risk remains (unusually) the most significant and that means normal economic considerations are out the window, it is best not to bet on the direction of interest rates but to assume a revaluation downwards in equity markets as troubles build up. In that case, I prefer to hold cash.