Thursday, September 5th, 2019
Do you sometimes get the feeling that life’s certainties, the things we usually take for granted, are actually quite uncertain? That the activities we all do daily, like breathing clean air, or perhaps walking to your office in the city, are in fact fraught with risk? Watching huge swathes of the Amazon on fire, sometimes described as “the lungs of the earth”, is disturbing. Brazil’s Sao Paulo was plunged into darkness as a result of the fires, as smoke from more than 1,700 miles away saw “day turned into night” across this city of 12 million. Apparently, the Amazon produces about 6% of the oxygen currently being made by photosynthetic organisms alive on the planet today. In this age of climate change anxiety, images like those uncontrolled fires justifiably upset our equanimity.
More than 70,000 fires are burning across the Amazon rainforest
Similar feelings of heightened risk and uncertainty periodically sweep across the investment markets, and for some of us, now is one of those times.
Why now? Are not investment markets inherently and always risky?
It is true that markets are by their nature risky and uncertain, but there are times when the road ahead is clear, markets are reasonably priced, political developments are relatively stable, central bankers are calm, business people are happy to invest, and consumers are feeling “comfortable and relaxed” (to use ex-PM John Howard’s phrase). Now is certainly not that time.
PM John Howard going for a power-walk in his trademark tracksuit: a more relaxed time
What could possibly go wrong?
- Since January 2018, almost every major economy has seen a deterioration in its purchasing managers’ indices. PMIs are one of the best forward-looking indicators of economic conditions for the manufacturing sector, a bellwether for overall economic activity.
- Germany, the UK and Italy are probably already in recession. China is slowing.
- Negative interest rates, and monetary stimulus are close to being exhausted. No-one really fully understands the long term consequences of the collapse in rates.
- Inverted yield curves are signalling problems ahead.
- There is market complacency bred by a decade of low interest rates and central bank QE.
- Economic globalisation and years of easy monetary policy have buoyed asset prices and favoured capital over labour. Politics are turning populist.
- The US/China trade war may not be resolved; in fact, other trade disputes may erupt.
- President Trump is unpredictable.
- Geopolitical tensions remain in Hong Kong, India/Pakistan, North Korea, Iran.
- One big sovereign default (Argentina, Venezuela, Italy?) or a cascade of corporate bankruptcies, and we could see markets fall.
- What happens in the UK if a general election, before or after a no-deal Brexit, sees left-wing socialist Jeremy Corbyn take power? His policy is to re-nationalise large parts of the British economy.
- What could be the impact of an Elizabeth Warren or Bernie Sanders victory in the US primaries? US taxes would probably rise in the event either one beat Trump.
- We are at risk of synchronised global recession, punctuated by a step-by-step market downturn — one in which there may be the odd rally, but the general direction is flat or down.
- Markets are still expensive, the cycle is old, and corporate earnings expectations look poor.
- Downside risks appear greater than potential gains.
Did we mention that President Trump is unpredictable? Trump is not without his supporters, and some of his policies have been welcomed by the Washington establishment (e.g. confronting China about unfair trade practices, requiring Nato allies to bear more defense costs, cutting taxes, etc.), but his unpredictable and erratic behaviour (such as threatening to fire the Chairman of the Federal Reserve, Jay Powell) means that the market remains deeply unsettled. It is hard to imagine what the next 14 months, in the run-up to the presidential election in November 2020, holds in store.
Source: David Rowe, AFR
The list of risks above is hardly reassuring for investors – even for long term investors who are prepared to look through temporary volatility. And none of this comes as a surprise to us. We have regularly discussed many of these issues in The View, in Clime Investing Reports, and in our monthly and quarterly client reports. We are holding elevated levels of cash in most portfolios (generally between 10% to 15%), in accordance with mandates, as a risk mitigation tactic, as well as to take advantage of volatility to invest in attractive stocks at reduced prices. We remain vigilant for any changes in the macro environment that require changes in positioning.
There are practical, sensible solutions to ensure that you can feel relaxed and comfortable with your investment portfolio.
What should you do?
There are many strategies for protecting your portfolio as circumstances change. Here are a few:
- Diversify. Ensure that your assets are spread across a range of asset classes. For example, if the listed market is vulnerable to volatility, directly held property will not be to the same extent. Although cash is not generating much of a return at present, it is relatively “safe”. Clime portfolios generally have around 10-15% cash levels to dampen volatility and to keep “some powder dry” to enable us to buy cheap stocks in the event of a downturn.
- Ensure your asset allocation is fit for purpose. While an aggressive or balanced portfolio may be suitable for a fifty year old who is still working, it may not be appropriate for a retired 75 year old.
For example, Clime’s Australian Income Fund (CAIF) is aimed at conservative investors who are seeking a return in the range of 3% above the RBA cash rate, after all fees and expenses. The CAIF has in fact returned 6.5% per annum, after fees and expenses, in the 3 years to end July 2019, with a level of volatility less than a third of the ASX. See CAIF details here https://www.clime.com.au/invest-with-clime/clime-managed-funds/clime-australian-income-fund/
- Portfolio managers at Clime have the ability to actively select equities which are less risky, by focusing on high quality companies with low debt levels, strong balance sheets, long track records and sustainable dividends. For example, healthcare stocks are generally less vulnerable to an economic slowdown or recession than are many retailing companies.
- Focus on yield: many investors focus on capital growth, but neglect the important role that yield plays in total portfolio return. While there are of course many cases where high growth stocks have a place in a diversified portfolio, there is also a strong case to include some high yielding companies (such as mature industrials, infrastructure, hybrids and A-REITs).
- There are other strategies for protecting portfolios, such as buying “protection” from market falls (e.g. an Exchange Traded Fund, such as BBOZ, that rises in value if the market falls), or even diversifying a small part of one’s portfolio into a hedge such as gold.
- The best advice is to engage with your financial adviser, review your portfolio and ensure it remains appropriate for your particular needs and circumstances. Certainly Clime is ready and willing to engage in this process with you, providing transparent high quality advice and having access to a wide range of high performing investment solutions.
Famed investor Howard Marks – of whom Warren Buffett said, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something…” has some wise words of advice which are worth repeating:
Howard Marks of Oaktree Capital
- Investing is not black or white, in or out, risky or safe. The key word is calibrate. The amount you have invested, your allocation of capital among the various possibilities, and the riskiness of the things you own all should be calibrated along a continuum that runs from aggressive to defensive.
- It’s not what’s going on; it’s how it’s priced… When we’re getting value cheap, we should be aggressive; when we’re getting value expensive, we should pull back.
- If it’s true, as I believe, that (a) the easy money in this cycle has been made, (b) the world is a risky place, and (c) securities are priced high, then people should probably be taking less risk today than they did three, five or seven years ago. Not out, but less risk and more caution.
- Observations regarding valuation and investor behavior can’t tell you what will happen tomorrow, but they say a lot about where we stand today, and thus about the odds that will govern the intermediate term. They can tell you whether to be more aggressive or more defensive; they just can’t be expected to always be correct, and certainly not correct right away.
- Even though no one can ascertain when we’re at the exact top or bottom, a key to successful investing lies in selling or lightening up closer to the top, and buying or, hopefully, loading up when we’re closer to the bottom.
– Howard Marks
We will continue to monitor all significant and relevant investment issues. Clients are encouraged to speak to their investment advisers and ensure their portfolios remain “fit for purpose”. Clime’s wealth advisers are very well placed to assist clients in reviewing their portfolios.
Our portfolio managers will be looking for opportunities created by any instability. At the same time, we will maintain our disciplined approach to investing, and our preference for high quality equities with strong balance sheets, experienced management, and growth opportunities. The economic and market cycle may be at a turning point, yet even in such an environment, there are many excellent investment opportunities for disciplined and focused investors. We remain vigilant and conscious of the need to prudently balance risk with the opportunities available to us and to our clients.
You deserve to feel relaxed and comfortable about your investment portfolio. We can help you with that.