Get Well Soon!

Low growth and high inflation – the UK economy maybe out of the emergency room but we are still in intensive care.

The huge cost of rescuing the economy from recession and bailing out the banks has left a massive hole in the nation’s finances. The medicine required to reduce the deficit is austerity which means cutting government expenditure and raising taxes, helped along the way with a spoon full of sugar – low interest rates. For some time now, even with this sweetener, the economy has been finding the medicine a little too hard to swallow which has prompted critics of the Coalition’s plan to question the amount as well as the fairness of the distribution of spending cuts and tax rises. However, I am yet to be convinced of any alternative medicine than will work.

Our Nation’s finances are not that dissimilar to those of the Portuguese, the Irish and the Greeks, all of which have been bailed out in the past twelve months. These countries are all in the Eurozone where the responsibility for setting interest rates and as such the exchange rate via the single currency is controlled centrally by ECB (European Central Bank.). Fiscal policy on the other hand as in how much each country spends and how much they raise taxes, is left in the hands of each member state. Until the global financial crisis, all Eurozone countries enjoyed the same cost of borrowing, any past history of poor repayment was overlooked. This is not the case today and the weaker Eurozone members have seen the cost of their borrowing soar to an unsustainable level. With the benefit of hindsight the proposed bailouts were inevitable, as the alternative of sovereign default has been politically unpalatable.

However bailouts are not the solution, these are simply a temporary fix whilst something more permanent is worked out. For those countries accepting a bailout there is a hefty price to pay. Firstly, there is the loss of their fiscal autonomy – the right to manage their own finances. The government has had to persuade their people, their voters, to accept a severe austerity package and the consequential reduction in their standard of living. Secondly, there is the prospect of weaker economic growth – the ability of any country to service and repay their debt depends upon the growth of their economy, as tax revenue needs to be at least maintained to pay back their creditors. Whilst, austerity packages reassure bond holders, consumers and businesses become more cautious about spending so consequentially economic growth weakens. Squeezing more tax revenue out of a shrinking economy is a challenge. In the past, Portugal, Ireland and Greece have devalued their currencies to encourage export growth. Devaluing the Escudo, Punt and Drachma is no longer an option, they are all part of a single currency where exchange rate policy is controlled by ECB. The Euro has been a relatively strong currency and this month’s hike in interest rates to hive off inflation fears will not help foster economic growth.

In the UK we have an advantage because we have more control over both our monetary and fiscal policy, although this is still limited by the wishes of our bond holders. Sterling has been devalued, in line with the plan to replace consumer spending for export growth. Whilst the competitiveness of our exporters has greatly improved, import prices have also dramatically increased with a weaker pound. The other major part of the Government’s fiscal consolidation plan, is to encourage the private sector to replace government investment as the proposed spending cuts start to bite. Investors should expect to see looser regulation and more tax incentives for both new and existing private enterprise to promote this initiative.

For all the autonomy we have to manage our own public finances, there has been a cost in lower economic growth and higher inflation. Inflation remains stubbornly above the Government’s 2% target and is considerably higher than most other developed economies. Whilst every part of the global economy has seen inflation rise as result of soaring commodity prices, inflation in the UK has taken on the additional price changes due to the increase in VAT and a weaker pound. The MPC (Monetary Policy Committee) at the Bank of England, which has the role of setting UK interest rate policy, has repeatedly stated that they believe the above target inflation is only temporary. It is clear from the recently published minutes of their last meeting that they are a long way from raising interest rates particularly with no signs of wage inflation given the high unemployment numbers. It seems to me that interest rates will only begin to rise either when we see a pick up in wage inflation or we experience a couple quarters of higher than higher economic growth. Until then household incomes will continue to be squeezed by low returns on cash deposits and increases in the cost of living. With the consumer representing almost two thirds of economic activity, this means weaker growth for the foreseeable future.

This weaker economic growth has clearly been reflected in lower Gilt yields in the last quarter, in recent months the yield on ten year government debt has fallen from around 3.8% to close to 3%. However these falls have exceeded my expectations and begs the question are there other factors at play here. It can be no coincidence that the fall in Gilt yields has occurred as Eurozone government bond yields in the weaker countries have soared over renewed fears of a sovereign debt default. This seems to support the fact that that bond investors still consider Gilts to be a safe haven and approve of the Government’s handling of the UK economy. Or, perhaps, maybe there is a belief that we will see further quantitative easing should weak economic growth persist.

When looking at the UK economy it does seem that it has lost steam over the last year. Some commentators are saying that this is only to be expected following a major financial crisis, however there has also been a weakening in the global economy following the supply chain issues caused by the Japanese earthquake and tsunami as well as the spike in commodity prices. The resultant weaker global trade has delayed the expected boost from a lower pound. For my part, I am not in the deflation and further recession camp at this stage, I believe that Gilts are a very expensive asset to own and that equities will offer far greater value over the coming year, however I am cautious in the very short term as investors focus on the plight of sovereign debt in the Eurozone. Furthermore I believe that economic weakness also threatens the longevity of the Government’s austerity plan which is not only based upon spending cuts but also on increasing tax receipts from a growing economy. I am not sure that Plan B, one which necessitates a slower pace of fiscal consolidation, will work as I believe that bond investors will not continue to lend at the current low levels of interest rates. The real fear is that a policy error may send our fragile recovery into another recession and straight back to the emergency room.

John Husselbee,
CEO North Investment Partners
1st August 2011

Note: John Husselbee is fund manager to the WAY MA Cautious and WAY MA Growth Portfolios. He started his career at Rothschilds in the mid 1980s and for more than 20 years of the intervening period has specialised in multimanager investment. Before launching North in 2005, John was the Director of Multi Manager Investment at Henderson Global Investors and prior to that headed up Rothschild’s Multi Manager business. John is a well-respected commentator within the industry.
www.waygroup.co.uk

Posted on 1st August, 2011 | Tags: Inflation, Recession, Spending Cuts, U. K. Economy |
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Going for gold – 5 reasons to consider

The top performing asset class of the last decade was gold. Only toward the end of that period did ‘ordinary’ investors take advantage however, as routes to the market opened up. Now we see TV adverts every day looking for scrap gold and Harrods selling gold bullion, so is this a precursor for a classic asset ‘bubble’ prick? WAY do not believe so and here are five reasons why…

From January 2000 to December 2010 the return on gold was 277%, outstripping all conventional asset classes. Though a number of technical analysis readings suggest that the bull market will continue for a ‘second wave’, there is concern that the increasing populist aspect of the asset is indicative of a market that has run its course.

The latter is an understandable emotional response given what has been seen of some other asset and thematic cycles in recent times but the relative comparisons are difficult to match up. Consider the following:-

• GOLD AS MONEY

For centuries gold has stood as a proxy for or alternative to cash and its value has been historically reflective of that position. That descriptive changed in the 1980′s through 1990′s as disinflation became the universal goal and the returns from equities and financial assets were robust. Essentially, gold was re-classified in investment terms as a pure commodity. During this period gold fell from $850 per ounce in January 1980 to $252 in July 1999, a true bear market.

We now stand at a point where quantitative easing has been deployed by the major economies to the extent that the USA have printed more money in the last 15 months than they had run off since 1984 to that starting point. The global risk must become universal inflation of an accelerated kind and devalued paper money.

Gold’s re-rating in investors eyes as a cash alternative looks highly probable with such a backdrop, providing true support to price valuations. However probable, let’s not just assume inflation will be rife just because it supports the gold argument. Some economists are starting to forecast Japanese style deflation for the UK stating a moribund economy combined with stagnant credit conditions. Indeed there is substantial anecdotal evidence that for the first time in living memory that UK consumers are paying back debt. Here the Japanese experience is especially valuable, Japan as everyone knows has suffered the conditions described for the last decade during which time the Yen price of Gold has risen by 300%.

This is fairly conclusive evidence that Gold can also prosper in deflationary conditions as well. Furthermore a weak UK economy will tend to produce a weak sterling exchange rate (indeed it this trend has already started) and Gold & Gold assets offer UK investors a perfect currency hedge that comes without paying fancy fees associated with many structured products that attempt to offer protection against the likely decline of the pound.

• GOLD DEMAND

In recent times the supply and demand equation has been relatively simple and broadly equal. The tonnage of mined gold can be pair matched with fabrication demand, e.g. jewellery, dentistry, etc. Whilst additional supply from merchant bank and scrap gold sales has matched investment demand. The latter is increasing however, with China in particular swallowing up gold in preference to US treasury bonds. This looks certain to continue as the economy of the former continues to grow and, due to reasons mentioned earlier, the latter seem unlikely to prove attractive for some time yet.

• GOLD SUPPLY

Whilst demand grows it is unlikely that supply has the capacity to increase in line. South African fields are now 90% exhausted with, as example, the largest gold field ever discovered, Witwatersrand, now producing about 230 tonnes a year (10% of world production) down from its peak of 1,000 tonnes in 1970. Canada, US and Australia have further potential but this cannot be turned on ‘like a tap’. Additional prime to supply as in the 1980′s and 1990′s by the Western governments and banks selling off gold reserves has all but finished. The auction of half the UK’s reserves at 10% from the nadir in price – ‘Brown’s Bottom’ – being amongst the most unfortunate of disposals. So, growing demand and a supply mechanism struggling to keep pace should continue to underpin gold’s future prospects.

• GOLD, INFLATION ADJUSTED

There is twitchiness in the market about the current gold price despite the positive fundamentals. To a degree this is spawned by the wariness of commentators new to this asset class and more familiar with financial, particularly equity, markets. The $1000 threshold has been crossed and this is perceived as a neat high tide mark. However, at the peak of the previous bull phase in January 1980, gold was priced at $850 per ounce. Using the most conservative measure of US inflation the equivalent today would see gold trading at $2,300. With the current price not quite half of that figure it is easy to see why supporters eschew the notion that we are in a bubble. Rather, this is further evidence of the potential.

• RELATIVE POSITION TO OIL AND DOW JONES

To check the relative validity of the gold price it is helpful to check against other key measures. Another key commodity, oil, has had its own bull run, paused for breath, and is now moving upward again but the gold price is still sitting below its 40 year ratio of 15.1 relative to the ‘black gold’. It remains in the zone where arbitragers would be shorting oil and going long on gold. The current DOW/Gold ratio sits at 9.29. An 80 year check against the respective indices shows Gold peaking when within a 1-5 ratio of the equity index. With the DOW currently at 10,000+, this would indicate a target of $5000 per ounce! These relative comparisons are, of course, moving feasts but are a useful sanity check on the prevailing price.

For the ‘ordinary investor’ gold has seemed a little remote but the routes to investment have increased in recent years through additional fund offerings and ETFs. Inexperience will bring caution and perhaps fear that the gold race has already been run. However, with equity markets and bond markets having a far from certain near future, there does seem to be a strong case to further diversify investor portfolios and place a proportion in gold at this very juncture.

Eddie O’Gorman
WAY UK Head of Sales & Marketing
12th March 2010.

Posted on 12th March, 2010 | Tags: Gold |
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Plan for the worst!

Hope for the best but plan for the worst! Most folk like just enough uncertainty to keep life interesting but not so much as to make them over-anxious. Unfortunately, the current environment puts many people in the second camp.

We are currently facing a ‘flu pandemic and whilst most of us logically know that the chances of it affecting us very badly are relatively slim, we still hate the suspense of waiting our turn at the snuffles. This feeling is exacerbated by the Press, especially when they splash all over the newspapers that yet another apparently healthy individual has (sadly) died from swine ‘flu.

In the wider world the economic and stockmarket uncertainty is also corrosive. Unemployment is rising fast and has a long way to go yet, public sector, corporate and private debt levels are testing and house repossessions and bankruptcies are likely to continue heading northwards. A prime example is the news emanating from Lloyds TSB, which is releasing all its bad employment news incrementally (hoping we won’t notice the big picture). Its recent announcement, which takes target group redundancies above the 8,000 mark, is unlikely to be its last.

And again, the Daily Mail recently reported that senior Tories are now privately admitting that the aspiration to raise the inheritance tax threshold to £1 million and scrap stamp duty for first-time buyers on homes worth up to £250,000 may be delayed because of the recession. One could say that Ken Clarke had already let that particular cat out of the bag in March but it was vehemently denied by the Cameron camp at the time. Personally, I am old enough to know that very few new governments fulfil their manifesto promises made whilst in opposition – and quite understandably so, since they construct their manifestos on grand assumptions which are often far from the subsequently discovered truth (once they actually see the books)!

This leaves investors very poorly served, especially those more elderly and wealthy individuals who should be tackling their Inheritance Tax (IHT) situation sooner rather than later. As one of my oldest and longest-standing friends likes to say: “Hope for the best but plan for the worst.” This is what I would recommend to all those taxpayers who are worrying about whether they should take action to avoid or reduce IHT.

Yes, you should take action. Take all the various steps you need to reduce your potential tax, including getting the 7 year clock ticking now and/or lending financial assets to specialist trusts at currently depressed values. If it subsequently transpires that the planning is not needed then any carefully considered planning can be effectively unwound. Using the right vehicles will incur little extra costs beyond the standard costs associated with establishing any other kind of investment strategy. This warning may sound alarmist but the uncertainty over IHT will be with us for at least another year – until the next General Election – and even then the news is likely to be negative for many years to come. And especially so at a time when there will have to be massive cuts in public services and across the board tax increases to re-balance the nation’s books.

The bigger uncertainty at the moment for most people is the state of the UK economy. Recent stockmarket rises would seem to imply that the recession is all but a thing of the past. And yet many serious pundits are warning of much worse to come. Logic does appear to suggest that the combination of sky-high debt levels across the public, corporate and personal sectors and the delayed effects of the economic slump have not fully worked through the system. With banks still re-building their balance sheets (and likely to continue to do so for some time), lending is not going to improve any time soon. Whilst many individuals and companies have been able to manage their deficits over the last year one can imagine that a continuation of the current credit and earnings drought will eventually take its toll.

My own view is that this cycle will, just as with every previous cycle, pass and we will see recovery. The uncertainty for everyone is when that is likely to happen. With the banks apparently terrified to lend to property buyers, entrepreneurs or even established companies; with southern and eastern Europe all on the verge of bankruptcy; with UK unemployment likely to sail through the 3 million mark leading to more distressed debt and property repossessions; with most stockmarket companies likely to slash dividend rates over the coming months and with the threat of a return of inflation just around the corner, the uncertainty will continue until at least the autumn and probably a great deal longer.

It seems appropriate to end by reminding you again of my friend’s apt catchphrase: “Hope for the best but plan for the worst!” And to reiterate what I’ve already said elsewhere, that this is what I would recommend to all those taxpayers who are worrying about whether they should take action to avoid or reduce IHT. In fact, I would only add one rider to all of the above: “- and do it now!”

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th August, 2009 | Tags: Financial Planning |
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Short-termism or short-sightedness?

On a recent trip to Devon, I stayed in a small and rather delightful hotel run by its proprietor, an ex-City currency trader. One increasingly comes across ex-City or ex-financial services folk who have left the industry for one reason or another.

Over the last year this trend has been accelerated by firms ‘letting people go’ in droves. In many cases redundancies have been across the board and highly-skilled and experienced people have been forced out of longstanding and necessary jobs. This is particularly true in the areas of sales and client servicing which, in many companies, have been left decimated.

Unlike many other sectors of industry and commerce one of the main assets within financial services companies is the skilled biped. It is these creatures which create and retain the other main asset, funds under management.

I find this distasteful British redundancy cult more than strange because as we come out of recession it is precisely those front line staff which were recently ‘let go’ that will be most important to financial services companies in the upturn.

I would go further and suggest that even before any recovery – in other words whilst still in this major and damaging equity/investment recession – investors and their advisers need as much help and support, if not more, than at any other time. And yet at the slightest whiff of a downturn companies get the knives out and slash away at sales and client support teams. This was happening as early as last Spring before the recession had really started – no doubt by companies wanting to correctly second guess the market and be seen by shareholders and the stockmarket to be doing the right thing.

One has to ask why companies do this because it seems that in most cases it is superficial and short term whilst being extremely damaging over the longer term. Being at the helm of a company which is 12 years old I would be very loathe to lose a brilliant team that has taken more than a decade to put together and assimilate into our particular culture.

I remember coming out of the 2000-2003 bear market with a full complement within sales and client servicing (the senior member of which we recruited in the middle of the downturn). This allowed us to steal a march on most of our direct competition which emerged blinking into the sunlight in the Spring of 2003 quite unprepared and without adequate resources to capitalise on the ensuing recovery.

I am pleased to say that our shareholders remain committed to our long term growth and sustainability – playing the long game – and are prepared to sit out the short term vagaries that have plagued stockmarkets over the last decade.

This time I have been and remain of the opinion that the recession will be V-shaped rather than has often been the case, U-shaped. This is even more incentive to maintain optimal service levels and retain the talented staffing which is required to make the most of the prospective market recovery.

This attempt by slash and burn management to appease both existing shareholders and the stockmarket by trying to maintain profitability when revenues fall is generally at best ill-conceived and at worst downright dangerous. Unfortunately, almost regardless of these irrational and short term measures, and any impact they might have on their P&L, their share price will generally fall with the sector anyway!
Surely the better option is to plan for the long term benefit of the company, the shareholders and the share price?

Volatility as a result of a fickle market should not distract management from their long term goals and planning. We are constantly warning investors to think in the long term and so should we.

Most highly successful and longstanding companies have not grown by adopting such short term ‘stop-go’ strategies. Of course, we all try to cut unnecessary costs during a recession but we should not cause ourselves lasting damage by permanently removing vital assets – our best people.

One of the most challenging aspects of contemporary life is the constantly increasing rapidity with which everything happens. This is largely the result of advances in speed and reach of the media as well as the continuing IT revolution. The irony is that with everything occurring at increasingly rapid speed there is little point in ‘short-termism’ because the landscape will have changed by the time the ‘short term’ measure has taken effect.

Unfortunately, we seem to be caught up in this senseless pursuit of instant but superficial gains. One of the most recent examples is the Government’s movements on higher rate Income Tax and the removal of the personal allowance for high earners.

This measure is destined to raise nothing for the country’s broken coffers in the short term, but will cause immeasurable damage to the economy in the longer term by removing the desirability of the UK as a place to do and locate business.

Looking around at the behaviour of most of the major financial companies over the last year I am at a loss to understand why they have put so many people through so much redundancy heartbreak when in very short shrift they will be recruiting once more as the markets take off.
In my view short-termism is generally better described as short-sightedness.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 26th June, 2009 | Tags: Economy |
Comments: One Comment