Four major colliding factors impacting economic investments 'post-Covid'.
31 October 2021
Reviewing the factors impacting investments
The big picture
If you've been following us over the past year you’ll know we took some significant positions for clients last year in response to the changes we were seeing, these being:
Firstly, we identified a potential problem with inflation; and Secondly, we were concerned about the valuation of certain markets and the potential for poor returns.
To manage these problems, we:
Introduced a significant amount of inflation linked bonds into our portfolios; and Also changed our asset allocation to avoid expensive types of investment and areas of the global markets.
Our positions have had mixed results so far but the risks are increasing and we believe our caution is even more necessary than before.
The last 12 months
Our view on inflation has worked well and we’ve so far been proved correct both in it happening and why it happened. The inflation linked bonds we purchased for our portfolios have performed well and have added significantly to returns for lower risk investors.
Our record in the stockmarket has been more mixed. The pivot to relatively cheap shares in the form of value funds has worked well and we’ve matched market performance here. We expect future gains from these holdings but there has been nothing lost so far. Elsewhere we have become very underweight in the US relative to the UK stockmarket and this has been detrimental to performance. We think the US market overall is in something of a bubble. However, over the last year the market has continued to rise in value. The result has been strong performance for lower risk clients but in the short-term disappointing returns for higher risk portfolios.
Putting the short-term performance of markets to the back of mind I am confident that our positioning is in the best interests of our clients. Picking the exact time when the current trends reverse is very difficult but very high valuations of certain assets at the same time as we see unprecedented risks is a toxic combination. Being cautious for now reduces the risks for our clients and should also lead to better long-term performance.
I believe the background today is riskier than I've seen in almost 30 years. I can see four significant global risks that aren’t picked up properly by markets, these being:
The first is this significant property sector unwind that's happening in China. Property sector there is going through a major reorganization but has represented almost 30% of total Chinese GDP. This is about 6x larger than the equivalent in the UK or the USA. Total square footage per person is already at the level we have in western Europe so there is no case for continued investment at this level. The sector must shrink considerably over the next 10 years. Even if managed very carefully by the Chinese state it is hard to see anything but low overall GDP growth for China for many years. The largest Chinese property developer appears to already be facing bankruptcy and the rest of the property sector is also struggling. We aren’t feeling the scale of this problem yet but in the next few months we will see it in revenue, profit, and price of certain commodities globally.
The second problem is the slow-motion car crash at the centre of EU financing of governments. Under the cover of COVID, the ECB introduced a program where, over the 18 months it's been in operation, they've now bought directly nearly 2 trillion euros of bonds from individual countries. The ECB buying these bonds has effectively socialized the liabilities at EU level making it the responsibility of all EU governments. This program has been very heavily buying bonds from Portugal, Italy, Spain, and Greece, and unsurprisingly, because this wasn't what people agreed to when they entered into this arrangement in the first place, the German supreme court has ruled this unconstitutional. We don’t know yet how this will be resolved but it is very possible that the EU are forced to stop buying bonds in this way. This would be a very significant monetary shock and is not currently priced into asset markets.
The third risk comes directly from the impact of inflation and its effect on people's disposable income. Rising costs of food, energy and other traded goods directly reduces the money people have available for other items and will lead to less purchases. This is a major depressive influence on the economy and is global because inflation is now everywhere.
All of this is happening at the same time as the fourth risk is unfolding. After very heavy state spending and central bank intervention to help manage Covid most governments are now being forced to reduce support. This is either less spending, higher taxes or less direct bond purchases from central banks. These are again happening at the same time across most of the world. In the past reductions in spending like this have led directly to recessions.
Each of these problems could be a significant but all of them coming together is something that we should be concerned about. As such, now is a time to be cautious within portfolios and wait for better opportunities to take risk.
Category: /Fund Management Industry News, Risk Management
Flying Colours Life Investment Management aims to make investment management more accessible and transparent for clients. Our roots in investing money on behalf of our clients, and our motivation lies in a genuine desire to make a difference to people’s futures and maximising the potential for solid long-term returns.