Investors have greeted 2013 with enthusiasm, seemingly prepared to accept that after five years we have moved beyond the aftershocks of the credit crunch. Economic growth will be sufficient to keep the peace, yet not enough to scare the central bankers into withdrawing QE-style support. A plain vanilla world, not too hot and not too cold. Goldilocks is back nearly twenty years after she last made an appearance. As a result volatility has collapsed.
So far this year it has paid to be an optimist, but the prudent investor does need to consider a few disorderly notions just in case.
I am reminded of the time when Shimon Peres delivered the 1995 Alastair Buchan Memorial Lecture at the International Institute of Strategic Studies. At that time he was Prime Minister of Israel, but under pressure because it was thought that he was failing to deliver the right sort of leadership. His "vision" did not translate into a 30 second soundbite. Yet at the IISS he spoke for an hour without notes in his sixth language in a way that captivated a well-informed audience.
He developed half a dozen seemingly unconnected strands which he then brought together in the last five minutes in a memorable and relevant way.
A few thoughts for consideration:
Setting aside the background noise that drive the tactics of investment management, three issues may well dominate the agenda for years to come.
- What are the implications of the transfer of wealth from Developed to Emerging economies?
- Will QE, the massive monetary experiment being conducted at present, cause inflation or deflation?
- Should investors stop providing cheap finance to Governments and switch to equities after 30 years of bond ascendency?
Handling just one of these would be considered challenging. The interdependencies are clear, but the answers are not as obvious as often portrayed. Safe to say, it is unlikely that we will have the luxury of working on a sequential solution as, most likely, all the buses will arrive together.
Financial markets are highly complex systems. Not only do they evolve, but market time moves along at a very different rate to the smooth progression of the most accurate clock. There are times when market time seems to have stopped, others when it successfully impersonates GMT, but occasionally when it accelerates it can leave normal time far behind. At the moment, market time is running close to normal which is one of the reasons why volatility is low, but this seems strange given that the challenges are as formidable as those that we faced when the Iron Curtain came down in 1989-90.
It is worth reflecting on some large numbers as we tend to become obsessed by the daily diet of economic statistics which focus on minor changes at the margin. Billions are within our comprehension perhaps because there are now 7.1 billion of us. Economic discussions, however, are now dominated by trillions, but the scale is far harder to comprehend. To put it in perspective, a billion seconds is the equivalent to 32 years. Many of us can remember 1981, whereas if we went back one trillion seconds then we would be in the middle of the last Ice Age.
Global GDP is $70 trillion, Japanese savers have cash or near cash on deposit of around $8 trillion and the fund management giants based in Boston, manage $14 trillion. If these trillions start to move then the answers to the questions posed earlier will be self-evident.
Governments and Central Banks
Governments and Central Banks are focused on short-term issues and measurable results. Ensuring the stability of the financial system has preoccupied those in positions of authority over the last five years, but there are now signs that domestic agendas are becoming more important - job creation and economic growth. Fighting inflation has been downgraded and for the moment currency markets are taking the strain as the developed world competes to gain a share of emerging economy growth.
Resources, Skill and Practice
As passive investment strategies have grown in importance over the last 30 years, tactical asset allocation and stock selection skills have been downgraded in many institutions where, investment strategies based on shadowy statistical evidence take precedence. A straightforward analysis of company report and accounts would seem to be a better indicator of the future. To do this effectively requires resources and experience, but those of us who try are aware that being an active manager is becoming less competitive than it used to be.
Balancing the headline negatives with less publicised positive news will be the challenge. It is encouraging that neither the Italian political stalemate nor the Cyprus banking crisis have managed to unsettle investors. The Global Economy is in good shape and Europe does not seem to matter as much as it did a few years ago. Similarly, the bright lights of Asia are so far undimmed either by contradictory economic news from China or by North Korea. Company balance sheets are strong, but because margins are already high, costs are rising and consumers are unable or unwilling to pay higher prices, we may see more takeovers as companies fight for market share. Confidence breeds confidence and company managers are just as susceptible as private individuals. Decisions delayed are now having to be made.
Disorderly notions may not lend themselves to a pithy summary, but are an important component of a coherent investment policy. Perhaps the best way to finish this note is to take a step back and ask why do investors invest?
Answers will differ, but financial security is right at the top of most lists. People, and there are a lot of us who are not only living longer, but also becoming wealthier, are coming to realise that taking some risks will be necessary to maintain the real value of their savings after inflation, tax and the withdrawal of a modest amount of income. The recent strength of markets is evidence that cash is being put to work.
By the way, Shimon Peres concluded his speech by saying that the next "serious" war in the Middle East would be about water not oil. We will see.