That Was the Year that Was
Appearances can be deceptive. The statistics will show that 2019 was a golden year for equity investors. Indeed, the majority of markets around the world have recorded gains that outwardly defy logic. The S&P 500 Index, the main equity index of the United States and bellwether of global investment, rose by an astonishing 29%. This was a year marked yet again by low inflation and low economic growth, but with the added complications of so-called trade wars, renewed Middle Eastern tensions, a prevaricating Federal Reserve and a looming impeachment trial. As usual, however, all is not what it seems.
It was extremely fortunate that 2019 started on 1st January
In last July’s edition of Underneath the Arches we argued that it was extremely fortunate that 2019 started on 1st January. By an accident of the calendar, the beginning of last year coincided with the end of a sharp fall in share prices. The same S&P 500 Index had dropped by a then alarming 20% during the tail end of 2018, a bout of lunacy that it corrected pronto in the first quarter of 2019.
In this brief review of the year gone by, we have thrown away our rose-tinted spectacles (although in this new era of sustainability, we have actually put them in the recycling bin). Yes, last year was a good one for investment markets, but it was not that good. One gets a much better perspective by putting the last two years together and saying that, on a rough average, the US market rose by 10% in each.
So if we smash the last two years together, the result is still quite a lot better than a poke in the eye with a kebab stick. Indeed, most of our opening paragraph still holds true. At a time that many experienced commentators consider to be as uncertain as they have ever known, global investment markets have travelled to the beat of a different drum. Despite everything – from the trade wars, to Brexit, Corbyn, Woodford, Iran, Saudi Arabia, Donald Trump, Europe, China’s slowdown and Exeter Chiefs losing the playoff final – the past two years have been remarkably productive.
Before we get onto 2020’s prospects, there are some important lessons from the last two years. First, but not necessarily foremost, markets are prone to shorter-term bouts of insanity. This is the nature of the beast. You will know that we try our best to avoid the notorious follies of forecasting, but we can absolutely guarantee that there will be more times to come when the financial markets convince themselves that the Four Horsemen are cantering up Wall Street.
There is an added complication to this these days, as the Regulators of our glorious industry have decreed that we must write to you each time the value of your portfolio has fallen by 10% during a calendar quarter. Now, as much as we strain every sinew and keyboard to ensure that this does not happen, it is inevitable that it will. Possibly not for more cautiously managed portfolios, but those accepting that these ups and downs are one of the prices of successful long-term investment, there will be a time when you receive a letter from us breaking the bad news.
The natural things to do when this happens are to do with reaching: a) for the whiskey and b) for the phone to tell us to sell what is left before that too disappears in a puff of smoke. The natural reactions are, of course, wrong. Had anyone panicked out of the markets this time last year because of the so widely and wrongly forecast recession, Trump, Brexit and the rest of the list, they would have missed out completely on the most spectacular recovery.
The second lesson is to ignore most of what you read, hear and otherwise ingest regarding financial markets. It is a point that we stress in almost every newsletter that we write. There are too many people in the worlds of both investment and media competing for your attention. The reality is that the world’s economy is going through what is, essentially, a prolonged spell of dullness. Reporting that, however, is not going to get you grasping for your television hoofer, or telephone, or computer, or even the Telegraph. It is a truism even older than your author that bad news sells. It is our job to cut through all the nonsense. If we truly believe that the aforementioned Horsemen are on the way, we will both tell you and also do something about it.
Ah yes, we should also mention that we had never invested with Woodford, nor had we ever been tempted to. No, we did not foresee all the unpleasantness, but his was an investment proposition that ticked none of our boxes. The funds and his ego were both too large, but above all Woodford’s performance had been miserable for years. It is quite beyond us why his fund(s) were included in anyone’s ‘best buy’ lists, which is a question that has yet to be satisfactorily answered by either the firms involved or the regulator. This is lingering dirty laundry that needs a very public washing and we hope that this happens in 2020.
2019 has ended on a wave of optimism. The United States and China appear to have made friends, the United Kingdom has a government and the threat of a recession has notably diminished. This is a somewhat curmudgeonly perspective, but it is a shame that financial markets have been so alive to the new outbreak of optimism. The American markets have ended the year at, or very near, record highs, further extending valuations that we struggle to justify.
There is much about 2020 to fuel a degree of optimism
It feels to us that the optimism has become overplayed. One of the many lessons that we have learned in the past few years is that in this era of long-term economic dullness, investors (possibly out of boredom) are prone to bouts of mania. As we have said, this was most apparent at the end of 2018; the madness is not quite so extreme at present, but it is inevitable that something will go wrong, somewhere, before too long, and we shall then be writing to you about another bout of collywobbles.
We suspect that one or more of the old favourites will flare up. Trump and China are likely to fall out again, while the unstoppable ticking of time towards the UK’s deadline for concluding a trade deal with the European Union is going to become increasingly stressful. As if to prove the point, whilst writing this article the news has broken that the United States has assassinated the Iranian General, Qassem Someimani. This is of potentially historical significance and we will be watching the likely destabilizing ripples with a degree of trepidation. We may be in the era of decarbonization, but we do not rule out the chances of another oil crisis. 2020 is also US presidential election year, something that we do not expect to be worry-free. For the markets, it will be as simple as ‘Republican good, Democrat bad’. No matter what our anglo-perspective is of Donald Trump, the markets will fear any sniff of a Democrat win in November.
There is much about 2020 to fuel a degree of optimism. There are also enough clouds in the sky to remind us that we need to keep treading carefully and sensibly. As ever, we set our sights on ensuring that our portfolios beat inflation; any help given to us in achieving this by rising markets comes as a bonus, not an expectation.
Jim Wood-Smith – Chief Investment Officer, Private Clients
The Crimson Tide
There is a fighting chance that this time last year you had not heard of Greta Thunberg. Love her or loathe her, the remarkable Swedish schoolgirl is now Time Magazine Person of the Year. Her international fame arguably rivals Donald Trump and Tiger Woods.
The likelihood is that she will actually achieve precious little
The likelihood is that she will actually achieve precious little. She has however an extraordinary talent for compressing complex issues into compelling simplicity. The quote below, from her speech to the Houses of Parliament in April last year, brilliantly summarizes the whole issue of climate change into four sentences:
“The climate crisis is both the easiest and the hardest issue we have ever faced. The easiest because we know what we must do. We must stop the emission of greenhouse gases. The hardest because our current economics are still totally dependent on burning fossil fuels”
Greta Thunberg, Can You Hear Me? Houses of Parliament, 23rd April 2019
The dichotomy is that the world needs to change the basis of hydrocarbon-based capitalism to even slow the rate of climate change, but will not (or cannot) do so because it is just too difficult. This state of affairs is not going to change, and it will shape the most powerful forces in the world economy.
The inability to make meaningful change to hydrocarbon-dependence means that temperature rise, and climate change, will become ever more apparent. There are obvious manifestations of this, in the Philippines, the Bahamas, Australia. But it will start to pervade daily personal and business life here in the UK. We will, for example, have to stop building housing estates in flood plains. This is only partly exceedingly obvious common sense, but also because it will be increasingly difficult (expensive) to obtain either a mortgage or insurance. The Bank of England has already started to stress test the financial stability of both banks and insurance companies across a range of three climate change scenarios; it is only a matter of time until ‘climate’ becomes a required factor in formal regulatory assessments and disclosures.
The march of climate change is likely to prompt a period of legislative catch up
The march of climate change is likely to prompt a period of legislative catch up, globally. Laws and regulation around the use of hydrocarbons will tighten, probably quite quickly as the decade progresses. Companies, and investors, will need to adapt. This is way beyond the usual electric vehicles, charging points and batteries.
A major part of this adaption will be efficiency. Not only will energy need to be renewably sourced, but also companies will have to use less of it. Raw materials will be less frequently ‘raw’ and increasingly re-used. Consumer behaviour will favour products in sustainable, or apparently sustainable, packaging.
For us, this is the great investment opportunity: the emergence of a new, low carbon, environmentally-aware, even circular, capitalism. We think that this message tends to become muddled with the other areas of co-called sustainable investment, of which there are two other clearly definable strands. First, the oil companies are typically lumped together with other ‘contentious’ activities, such as tobacco, gambling, alcohol, armaments and being horrible to kittens. Companies that carry out such perceived sins are then ‘screened’ out of, or excluded from, portfolios.
The second thread is now commonly branded ‘ESG’. The acronym refers to environmental, social and governance factors, these being alleged to be important in determining which businesses are best suited for long-term success. The concept is that those companies that have best practice in employment (from the board to the factory floor), in sustainable sourcing, in education, in welfare, in working with the societies where they operate, will ultimately fare best. Some may think that this could be branded as ‘common sense’; it would be hard to argue otherwise.
We have found that as 2019 passed, so there was a significant increase in this area of investment. This has been partly in our dedicated ‘Sustainable World’ service, but we have also seen a sharp rise in requests to have a certain percentage of portfolios invested into ‘sustainable’ funds and stocks, especially those designed to make a positive environmental impact.
As much as we believe that the future will be shaped by the climate and decarbonization, there is a price for everything. We are very aware that sustainable investment is not without risk and that the share prices of a number of favourite stocks around the world have already risen substantially, driven by this growing desire of investors to profit from the green revolution. One of the key skills of 2020 will be to avoid blindly following the herd and instead to keep searching for not only the right businesses, but to make sure that we invest into these at the right prices.
Jim Wood-Smith – Chief Investment Officer, Private Clients
Hawksmoor Investment Management Limited is authorised and regulated by the Financial Conduct Authority (www.fca.org.uk) with its registered office at 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. This document does not constitute an offer or invitation to any person in respect of the securities or funds described, nor should its content be interpreted as investment or tax advice for which you should consult your independent financial adviser and or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. The information and opinions expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represent the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested.