Its Not Harry

Comment and opinion for retail investors in the UK

Education

Trumping the markets

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I would expect investors to be wondering if the very real negative outcome of the G7 economic summit and the sham positive outcome of the Kim/Trump summit will have any impact on investment markets.

The lightweight answer is that as usual short term reactions are not connected with logic, economics or reality.  Asian markets reportedly went up because the developments in North Korea are ‘positive’, when in fact nothing will change that influences the climate for business in the Far East.  Developed markets, the larger company elements of which are highly dependant on global trade, are treating a potentially serious interference factor in the global trade mechanisms as if it just won’t happen.

As I have commented before, trade tariffs, embargos and sanctions have very unpredictable results because of the complexity of world trade.  If you put petrol in your diesel car, nothing happens to start with.  I know this, because I have done it twice! 

But later on the car reacts and in the end, if you don’t clean out the diesel immediately, you will have a non-functioning engine and at least a damaged diesel injector pump that is very expensive to repair.

I think the lack of impact on global markets of the break down in the free trade consensus may be just as dangerous, even if nothing happens straight away.

As for North Korea – well it may be an exploitation opportunity for a few mainly US corporates at some future date, but I can think of many more interesting investment stories.

Ciao!

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As anyone who has holidayed in Italy knows, this little word can mean hello or goodbye and is widely used in other cultures too.

Recently Italian bond markets made the financial news and it was very much a quick hello and good bye.

The political situation in Italy looked all of a sudden to be very shaky and ‘spreads’ on Italian bonds or loan stocks shot up.  In fact there was moment when global stock markets started speculating about a new Eurozone crisis.

What does it mean when ‘spreads’ move up?  It means that the difference between the interest rate investors expect to be paid to lend to the country of Italy (in this case) and its institutions and businesses, relative to the rate they require to lend to say the UK or US or Germany,  move up to reflect perceived extra risk.

For example, say an Italian bank was offering a 5% return on a fixed term bond the last time it borrowed money from the money markets, but now no-one will buy the bond unless it pays 6%.  In that case the spread has gone up 1% or 100 bps (basis points), assuming all other countries are borrowing at the same price as before.

The change in Italy mattered a lot to some investors running bond funds.   Italy is large industrialised country with some great businesses (not just food, cars and wine!)  but it has not got  a great reputation for security and stable government and so bond fund investors have been happy to own Italian loan stocks and pick up a bit more return that reflects the lower credit quality than say Germany.  But imagine you bought Italian bonds at prices that on average are giving you a 4% return in total if held to maturity.   If spreads shoot up the market might want 6% or even 7% returns over the period during which you are going to have to wait for your bonds to mature.  That makes your bonds very unattractive and in fact their value as a tradeable asset will have fallen very significantly overnight.

In the end a new pro Euro government has been installed, albeit the first really different government in Europe since the Greeks rebelled against austerity.  Markets calmed down, but expect to be hearing more about Italy in the financial as well as the culinary media!

Sell in May and go away?

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This phrase will be known to many investors.  It originates from the times when most City stock traders were from aristocratic or at least rich backgrounds and so they left the City for the ‘house in the country’ in May and came back in September – the ‘come back on St Leger’s day’ second part of the phrase.

As someone who spends a lot of free time reading classic books, I have always been fascinated by the way writers, sometimes themselves investors (or the offspring of unsuccessful investors!), recorded investor behaviour.  Anthony Trollope is a very interesting source on this subject especially in his bitter satire “The Way We Live Now”.

Readers of this blog will know I am utterly convinced from years of observation and quite a bit of reading  that human behaviour is at least to some extent predictable and undoubtedly drives share and fund prices as much as basic economic theory.

So, as the evidence is that on average the suggested course of action suggested would give better results in more years than not, I am not going to dismiss the saying as trite nonsense.  It may well reflect the general momentum of market trading.  On the other hand for the last couple of years it would have been a bad move to sell out of markets in April or May.

Taking into account where we are now, a thinking process I constantly stress needs to be applied when making investment decisions, the odds must be on banking at least some profits or keeping cash on the side ready to invest later.  My monthly reviews for subscribers will make more specific observations.  I would think there are plenty of reasons for taking profits from portfolios incrementally anyway, given the high levels of political risk around at present.

Of course, investors in funds can expect those fund managers who have the scope to hold cash or near cash in their portfolios to make the call for them.

Other longer pieces on the site discuss the merits of cash as an asset and of course the need to take a long term view.

Cash as an asset class

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Introduction

In various places on this web site, I suggest that holding cash as an integral component of your portfolio mix is a way of diversifying risk.  In the briefest terms possible, keeping cash on hand lowers volatility, saves you selling at the wrong time and gives you the opportunity to buy cheap assets without notice.  In essence I prefer what is called the ‘cash plus risk’ investment approach to the traditional portfolio construction based on the assumed non-correlation between equity shares and fixed income or loan stocks.

Where to keep it?

In practice there are 3 main ways you can hold cash as part of your investing strategy:  in your bank, building society or other deposit taking institution (or in your sock, if you really must!), as part of your platform or wrap assets, or in the control of the fund managers you select.

It is worth mentioning that the managers of funds that list as a primary objective investing in stock markets assets have inconsistent views on holding cash within their funds:  some say it is not their job to hold cash and they will always be fully invested, others say they must hold cash to manage liquidity (common for property funds) and a third group hold cash as a tactical asset (especially in absolute return funds).  If you get a ‘drill down’ analysis of your funds portfolio from your adviser or platform supplier, you may well find you are more into cash than you thought!

Holding cash in money market unitised funds that invest in deposit like instruments like floating rate notes or synthetic zero dividend preference shares (that can still fall in value but are low volatility) only works if the long term returns are better than bank interest rates after tax plus the fund fees.  That is sometimes the case, but the best funds will show losses for periods, albeit they recover over time.

Holding cash in private accounts is the favoured approach of most investors because they are in control, can keep an eye out for the best products from banks and building societies and have instant access.  Tax favoured offerings from National Savings are a good bet at times depending on Government policy to borrowing direct from the public which varies a fair bit.

Keeping cash in your platform or wrap account is ideal if you are going to use the money for dealing quite soon, but interest rates on such money may currently be negative after fees are taken into account, so I would suggest such holdings would usually be short term.  The better platforms do offer access to fixed term deposit accounts to squeeze a bit more interest out of the system, but of course that may constrain an opportunistic quick buy of an asset you just decided was priced where you liked it!

My view

I think only modest amounts, intended for dealing (possibly raised from recent asset sales) should be kept on platforms.  I think your cash ought to be in your control, but that you ought to know that “investment cash” is separate from your day to day funds and any emergency reserve for unexpected capital items that you like to keep.

It helps if you keep that portfolio strategy cash noted in your records with your other portfolio asset data if you want to measure your returns accurately.  In good times, the cash holding will be a brake on performance and there will be a psychological ‘itch’ to invest it but when markets fall, it will be something you can access while you wait for things to get better and the psychology will all be positive!

Actually, in my opinion, holding a good cash reserve is not really a brake on good performance long term, because you can make the assets you do invest in that bit more adventurous and over time that will generally pay you back with better returns.  Recent research supports this supposition over more time periods than not.

 

House prices on the UK – on the slide?

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Confession

This piece is one of my occasional rants.  My ambition is to show readers that what gets quoted in the media (print or electronic) as ‘expert’ opinion is often out of context or plain stupid!  My ex-colleagues told me I was prone to ranting – my response is a rant is a proportional non-violent reaction to utter tosh being promoted as rational expertise.  It happens a lot in finance and economics!

Background

You may have read that the Halifax House Price Index reported a sharp fall in prices this month.  I used to work with the economist who created the original index, but no doubt is has developed since the 1980s.  Some suggest this was a ‘freak’ data item but I doubt that.   The on-line article then quoted the chief economist of an economic research business as saying something to the effect that ‘as long as interest rates don’t rise sharply and people don’t need to sell their houses because they can’t afford their mortgages, prices are not likely to fall’.  My hands were then moving to my head looking for a few remaining hairs to pull out!

Analysis and a bit more realism

Of course, repossessed houses coming on to the market in quantity would probably cause prices to fall very sharply, as they did in past recessions.  That is because of an increase in supply combining with a decrease in demand for owner occupation (partly mitigated by an increase in the demand for houses to rent).  That is just basic beginner’s economics.

However, what our chief economist friend seemed not to want to say (I am sure he thought about this) is that a more general reduction in demand alone, which we are actually seeing in London already, will also cause a fall in prices and a sharp reduction in demand will in time cause a sharp fall in prices.

For example, there are Brexit effects that are not much discussed.  Significant blocks of housing in the East Midlands especially are owned by or occupied on multi-tenant lets by Eastern Europeans.  I know this first hand – I live in Eastern Europe and have friends who have been to the UK to work, some returning home, some not yet, and my parents and sister live in the East Midlands.   That source of demand is already reducing as is evidenced by the shortage of labourers in some industries.

As Britain now appears to outsiders to be a more hostile place for foreigners (it is  – I was recently personally racially abused on a bus in Yorkshire on the apparent assumption that I was an Albanian), people with lots of money (eg Russian, Chinese and  Indian nationals) will not buy in London, which will turn off the main source of liquidity that has been driving prices in the South East too .  If net immigration falls as well, it is certain that demand side of the UK housing market equation will ease off.  That combined effect and possibly rising interest rates as well could mean a long down slope for house prices in those areas that have seen the biggest gains.  Maybe not a bad thing in economic terms, being just the turn of the cycle but falling house prices and recessions often come along together.