I am quoting and borrowing some thoughts from Robin Angus – author of the November 2016 Personal Assets Trust PLC newsletter:
“A sea-change in politics?
‘There are times, perhaps once every thirty years, when there is a sea-change in politics. It then does not matter what you say or what you do. There is a shift in what the public wants and what it approves of. I suspect there is now such a sea-change and it is for Mrs. Thatcher. – James Callaghan, 1979”
Generally, politics has surprisingly little effect on markets. What we are seeing with Brexit, Trump and now Italy may be different. Populism and “post-truth” politics can “….bring with it useful practical boosts to the economy such as tax cuts and higher spending on infrastructure, but also financial and economic horrors such as protectionism and capital controls. Perhaps it will just fizzle out. (‘Post-truth’ has been hailed as the Word of the Year for 2016 by Oxford Dictionaries. It is defined as ‘an adjective relating to circumstances in which objective facts are less influential in shaping public opinion than emotional appeals’)”. “When this happens (and we can see it all around us), political upsets are to be expected. It is comforting, however, to keep in mind that the results of changes in the political world are seldom either as good as we hope or as bad as we fear.”
“Nothing dominates the market, or sets its mood, forever. Things do come in cycles, but not necessarily nice neat ones that are predictable in length or in severity”.
“One thing these changes had in common is that they occurred at times when the prevailing market mood, whether of optimism or of weary resignation, had come to feel so entrenched that anything else was inconceivable. Ian Rushbrook, the founder of Personal Assets, was fond of saying that change at such times would come only when the market as a whole had ceased to believe that change was possible”.
“History proved him right, and I believe the future will too. Much of the forecasting we encounter ― whether it comes from banks, broking houses, think tanks, the academic world or the Bank of England, and irrespective of how dense and complicated is the algebra in which it is dressed up ― is not new or original, but at bottom consists of extrapolating present trends. Forecasts produced by this method are usually either useless or downright misleading. What those involved in managing money have to do in times like these is avoid the mechanical extrapolation of today’s prevailing tendencies and instead keep their eyes wide open for hints of developments that are genuinely different or new. That is how money is to be made and losses avoided”.
We must believe that common sense will prevail. A world of zero interest rates cannot be sustainable “… the use of money should command a fair price and that investments should provide a fair return. Capitalism is about risk and reward. You can’t have one without the other. Do away with reward, and after a while no-one will take risks. The result? Stagnation. Do away with risk, and after a while there will be no reward. The result? Stagnation again. …..since Alan Greenspan’s reign at the Fed ― governments and central bankers have done their best to abolish risk. Terrified of the electoral consequences of a recession and disbelieving my maxim that ‘recessions are good for you’, they have consistently denied the system the chance to clear itself. The result? A financial system that is out of kilter; a market which has moved so far ahead of the growth in the underlying economy that a lengthy catch-up period is required….”
Investment strategy
Currencies
Global politics has had a major effect on currencies resulting in dollar strength and a weakening Euro and Sterling. We have been fortunate to benefit from an overweight position in dollars. Until Brexit, we mostly held dollar cash in our international portfolios. Since Brexit we have diversified a little into Sterling. The surprisingly strong Rand has impacted our returns this year – this is the cost of diversification.
Asset allocation
For a few years, we have known that interest rates had to rise which would present a headwind to bonds and properties. On the news of Trump’s election, long-term interest rates spiked up in the US and bonds experienced a massive sell-off. We fear this is only the beginning of a reversal to a 30-year long trend of falling interest rates. For long term investors, there is no hurry to return to conventional bonds. On average, equities are expensive, so we have to be very selective (see more below). One cannot be an index investor now. This leaves cash which has little to offer international investors.
Fund Managers
We prefer the value style of fund management to the momentum or growth style. Momentum has outperformed for several years now, but since January 2016 a very clear reversal is in place. To quote Howard Marks of Oaktree Capital: “Momentum investing is based on the belief that something that has been appreciating is likely to continue doing so. Truth is, the higher the price (everything else being equal) the less attractive an asset is. Momentum investing works until it stops, at which time the things that have been doing worst, and may be most undervalued, take over market leadership. ….the investing herd is often wrong…but doing the opposite …isn’t a sure thing either. Much of the time there isn’t anything dramatic to either do or avoid. Contrarianism is most effective at the extremes and then only for those who understand what the herd is doing and why it is wrong – at which point contrarians have to summon the nerve to do the opposite”. Except for Foord, our chosen fund managers – Chiron, Allan Gray, Re:CM, Kagiso and Investec Value have been at the top end of the leader board this year.
Stock Selection
Our bet on the resource sector has paid off in 2016. Although we were early and suffered in the 4th quarter of 2015, we are now experiencing the benefits of this investment as the tide has turned. Our avoidance of the retail sector has paid off (see the attached graph from the Sunday Times). In the past twelve months, we have managed to avoid exposure to the ALSI Top 40’s largest fallers and have had exposure to some of the gainers (see the attached extract from the Financial Mail). This has resulted in outperformance of our peers and the benchmark.
In Conclusion
We are in interesting times indeed. We caution against being too focused on the scoreboard as it can be very distracting. However, an occasional glance is essential to know whether we are ahead in the game. We are still assembling and processing the year-end data, but early indications are that we are well ahead of most peers and benchmarks. We will report more fully in our reviews. We are grateful to have taken our pain early in the cycle, letting go of the old wave in favour of the new. We feel quite tired after a challenging year, but good about our portfolio positioning and confident that we are on track.