John Townsend’s Investment Opinions – September 2022
“The day is short, the work is much, the workers are lazy, the reward is great, and the master is pressing. It is not incumbent upon you to finish the task, but neither are you free to abstain from it.” – Rabbi Tarphon in the Mishnah. Pirkei Avot chapter 2 (Ethics of the Fathers)
The Russian invasion of Ukraine, following on the heels of the Covid pandemic and adding to price inflation has caused deep uncertainty in the investment markets. In times of severe insecurity, the instinctive reaction of the inexperienced investors is to sell as many of their investments in the affected areas as possible, especially those positions that were bought with borrowed money. At present, institutional investors have been heading for the safe haven of the US markets to invest in treasuries and large corporate equities.
Politicians in the West have tried to hold together in the defense of Ukraine though some voices, especially in Italy, and among some major German companies, have tried to press for a peaceful settlement where Ukraine should give up its territory, thereby giving the Russians a reward for their aggression, and at least reducing the risk of war albeit temporarily for the rest of Europe.
The Russian economy is weak and has been further weakened by the invasion. The threats from Moscow have become ever more blood curdling reflecting the increasing weakness of their position, up to and including the use of tactical (i.e., small) nuclear weapons on Ukraine itself, even if they are probably bluffing. The threats are more for the benefit of a domestic audience who have no alternative information sources but are noticing the casualties among their sons who have been poured into the furnace of a war. There is at present no viable opposition in Russia that has not already been locked up, so alternative news is hard and dangerous to come by. The propaganda from Moscow may be palpably wrong, indeed it may be utterly the reverse of reality, but it is hyperbole aimed at encouraging the home audience and discouraging the weak at heart in the rest of the world.
Russia is benefitting from the high prices its energy exports can achieve in those markets that are still willing to buy their oil and gas, for instance India, in place of its exports to Europe. Russia is also trying to assert itself by turning off the gas supply normally delivered by the Baltic pipeline Nord Stream 1 and thereby putting the European governments and their economies under pressure. Western Europe, having become complacent about the lack of diversification of gas supplies has been suddenly shaken by this move which has caused gas prices to soar by up to 10 times their previous levels. This move will not be long lasting, but it causes concern. The ensuing panic and the search for alternative sources of energy to circumnavigate the problem will cause much more rivalry and much less concentration on the real issues. The pressure is on in some political circles to abandon Ukraine and to gratefully resume taking Russian gas. Surely it would be better to remove the temptation to surrender for some European countries and buckle under the pressure and instead simply blow big holes into the Nord Stream 1 pipeline and its completed but not yet commissioned sister project Nord Stream 2 pipeline which was, in any event, a vanity project by a previous German chancellor which his successors did not have the courage to cancel, thereby removing them as an obstacle to finding a more logical and longer lasting solution to a diversified energy supply problem.
The equity market investment peak was reached in December 2021, after a period of increased volatility. European smaller companies (those with a market capitalization of between 300 million and 2 billion Euros) suffered severely as the search for quality and the covering of short positions took hold. I believe that the market’s low point was probably reached in September 2022, but unlike the rapid recovery from the Covid scare of March 2020, there is still plenty of room for panic and downward jolts and the recovery this time is likely to be much slower, Rising energy costs help to fuel household and industrial inflation which in turn need to be brought under control. Western central banks, after a period of supporting the markets with additional liquidity and quantitative easing during the Covid crisis are now reversing their actions by raising interest rates and slowly disposing of the bond purchases which had been used to give liquidity to the markets. The danger is always that the difficult times occurring now in the various markets will be emotionally extrapolated into the future, whereas they are unlikely to last for the long term.
A recession in the USA has probably already started and a recession in Europe is likely to follow by the end of 2022. However, the employment figures in the USA are encouraging and indicate a near term increase in demand. The strong boom years we have just experienced, have filled warehouses with inventories that need to be sold to make room. The economic recovery from the Covid shutdown will mean, however, that the recession will be quite mild. This is a time to look for value in the markets rather than to focus on the companies that have generated earnings growth for so long. Indeed, some companies can fall into both camps. It takes a competent fund manager with a good analytical team to find the right quality investments.
A recession, even a short-term recession, has an impact on the daily lives of everyone. Equities can lose their value or simply stagnate until a recovery begins. In the meantime, house prices will begin to fall from their already very high levels, as the money to buy properties is more difficult to borrow and consumers begin to worry about their ability to service debt. This is likely to be a mild recession however and the discomfort will probably be short lived.
In China, the attempt at a zero Covid policy by locking down whole cities has had a deleterious effect on the planned economic growth rate. In 2021 the Chinese economy grew at 8.08%, which greatly exceeded the centrally planned target. In 2022 this growth rate is likely to be 3.3%, the lowest in more than 40 years, according to IMF figures, and is expected to grow to 4.6% in 2023. Within China, domestic and industrial demand will continue at a lower level than in the past, but the economy is huge, behind only that of the USA. China is still an investible opportunity and brings with it investments in other Southeast Asian economies.
The five stages of grief are denial, anger, bargaining, depression, and acceptance. This can also be seen in the current investment market. Bargaining was seen in the summer of 2022 when investors hoped that the central banks would be gentle with base rate rises, which were in any event inevitable. They weren’t, so now investors find themselves somewhere between depression and acceptance. The developed market central banks seemingly had concerted programs of policy tightening, with base rate rises have coming in increments of 0.75% instead of the normally gentle 0.25%. The Federal Reserve has made it clear that it is willing to go much further in raising rates, if necessary, which is having a dampening effect on equity investors too. The tech stocks which grew so rapidly in early 2022 and formed the mainstay of the MSCI World index, benefitted from leveraged investors who are now bearing the brunt of diminishing credit availability and suffering from forced liquidations.
The fabled FAANG stocks, which are major components of the MSCI World index and together are an acronym so called after the US technology companies, Facebook, Amazon, Apple, Netflix and Google, have now become MANTA stocks, now Microsoft, Amazon, Nvidia, Tesla and Alphabet. Facebook, now Meta, has been downgraded in importance as has Apple. These stocks found favor with investors and were busily over bought. The inevitable over enthusiasm could not be extrapolated into the future and, like the Dutch tulip mania of the 17th century, it imploded when common sense prevailed. These companies do of course have their value and their logic, just not at the over-inflated price levels they reached during the craze.
Investors should not panic, and above all should stay invested at this time. The investment markets have already priced in the coming economic recession at least in part, by staying invested, investors will then move onto the final stage of the grieving process with an acceptance that the boom markets of last year are not going to be repeated in the near future. The news is uncomfortable but is not a cause for panic. Competent fund managers with the experience of many years of the ups and downs of economic and political upheavals will rebuild stability into their portfolios and profitable investing will resume, albeit at a lower level than in the recent past. A broad distribution of risks will also allow for stability in the yields of portfolios.
Investors should also resist the temptation of investing in the get rich quickly sectors such as Cryptocurrencies and other similar bandwagons. Recent history has shown that it is perfectly possible to lose most or all of an investment in this gamble. The coming years will still have profit potential, but not at the extravagant levels of the past.
The watchword remains; stay invested, but carefully diversify risk and avoid over concentration in any one sector.
Past performance is not a guide to and cannot guarantee future profitability. The value of investments and the income they generate may go down as well as up and investors may not get back the amounts they originally invested. All investments involve risks including the risk of possible loss of principal. John Townsend advises the clients of Matz-Townsend Finanzplanung with their investment portfolios. He is a fellow of the Chartered Institute for Securities and Investment in London.
John Townsend’s Investment Opinions – March 2022
“There are decades when nothing happens and then there are weeks when decades happen.” — Vladimir Lenin
The Russian invasion of Ukraine is a human tragedy ordered by an elderly autocrat with no popular support and will result in a great deal of innocent suffering. It is at present unclear how it will evolve, but it is likely to lead to the internal destruction of modern Russia. The events in Ukraine have changed the world, probably irrevocably, but we have seen crises before, and they have been met and mastered. It is important not to lose one’s nerve.
This paper does not set out to minimize the disaster, but rather to recognize the effect that this action will have on my clients’ investments. Clearly however, now is not a time for politicians especially, to be over friendly towards Russia and some political parties, in Europe especially, will lose their popularity. As it is, past pro-Russian politicians are issuing a deafening silence or are running from their erst-while ally.
The investment markets are unemotional when it comes to wars and human suffering. Past experience has shown that the aggression that we have seen since 24th February, as long as it occurs away from the global economic and financial centres, is not necessarily considered a disaster.
The traditional emotional response to international aggression is to react with fear and then sell one’s investments. Indeed, there is an international index known as the VIX, which tracks the expectation of volatility expected by traders in the US S&P index over the forthcoming 30 days. However, this would not necessarily be wise, despite the wish to show solidarity with the people of Ukraine and will hurt only the investors themselves.
And yet… tensions between Russia and Ukraine have heightened over the past weeks and the VIX index has risen sharply. Using the reverse of an old adage, the investment markets have been selling on the rumour and can now be expected to buy on the fact. On Thursday 24th February, the VIX closed at 30, well above its average since 1990 of 19. This is a sharply higher than the level 17 at the start of 2022. As the war progresses and casualties mount, the increasing sanctions against Russia could cause even this level could be exceeded.
The global investment manager Schroders points out that rather than being a time to sell, historically, periods of heightened fear have investors have in the past earned the best returns. To quote Schroders “On average, the S&P 500 has generated an average 12-month return of over 15% if the VIX was between 28.7 and 33.5, and more than 26% if it breached 33.5.”
Europe, which was just beginning to regain its economic composure after the Omicron/Covid pandemic is likely to suffer some weakness and a delay in its recovery in the next 2-3 months. However, once the situation becomes clearer economic growth will resume.
The uncertainty will bring with it a downturn in corporate growth. It is likely that Russia will drive energy costs much higher at least for a while. The big oil companies will drive the price of fuel at the pumps higher without much encouragement. Globally the economic impact will less hard-felt, though the belief in a short period of inflation before a return to normality is now likely to scotched.
The USA is likely to be less effected by events in the Ukraine. Especially as US growth has begun to rebound strongly. Much the same is true for China and the emerging markets, though slower economic growth in the developed world will affect these areas too. The US Federal Reserve, which had signaled aggressive interest rate rises in 2022/3 will probably wish to be more careful. Europe, being closer to the centre of the crisis is unlikely, after all, to want to raise interest rates for the foreseeable future. This will support companies and encourage investment even if it does also encourage continued inflation. Assuming no warfare creep outside Ukraine, after a period of reflection, perhaps three or four months, the investment markets are likely to return to their pre-crisis trends and activities. Post-Covid growth in Europe will probably resume; such growth has been held back for too long and is bursting to get out, so growth here could be quite strong.
The attack on Ukraine is likely to leave Russia itself badly scarred. Economic sanctions, as long as these are adhered to by all players in Europe, Asia and the US will prove expensive for the Russian people and could cause dissent there. It is worth remembering that the decision to attack was not a popular one, the Russian people were not consulted and have only to pay the price in terms of dead soldiers and economic shortages.
In the long term, again barring a military spillover from the present warfare there is unlikely to be an impact on European economies. Russian teams have become expert at Cyber-attacks on the West, whether companies or governments. It would be a surprise if these were not increased in the near future. The clear message will be the need to diversify away from a dependence on anything Russian, especially energy. This will further encourage the growth of renewable energy as well as nuclear power stations. US natural gas, delivered by sea will probably become interesting again especially as the Russians can so readily affect oil and gas prices.
It is possible that Russia will take over the Ukraine and the Russian Kleptocrats against whom personal international sanctions have already been announced, could take over the resources of the Ukrainian raw materials. This would be a major blow to those who sought to westernize the country. The cost to economic growth in Ukraine and possibly Europe will be immense.
Past performance is not a guide to and cannot guarantee future profitability. The value of investments and the income they generate may go down as well as up and investors may not get back the amounts they originally invested. All investments involve risks including the risk of possible loss of principal.
John Townsend advises the clients of Matz-Townsend Finanzplanung with their investment portfolios. He is a fellow of the Chartered Institute for Securities and Investment in London.
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