Review of 2012 to date
On balance, many major markets have been relatively kind to investors so far this year with fixed interest holding steady and continuing to provide premium levels of income, while equities have generally gained ground in both value and income terms. Index linked fixed interest funds have given up a little of their gains made over the previous couple of years, whilst elements that form smaller parts of clients’ portfolios, such as commercial property and commodity based funds, have sometimes not progressed.
The fact that fixed interest investments have provided a rock steady result is perhaps no surprise because, as I have been saying for some time now, interest rates look set to remain lower for longer than previously anticipated, while recent announcements from Ben Bernanke in the USA suggest very clearly that US interest rates are likely to remain at around current levels for 2 more years as an extended programme of quantitative easing continues. In addition, uncertainties in the Eurozone continue and more cautious investors have sought refuge in the apparent “safe haven” fixed interest markets in the USA, Germany, the UK and Switzerland and others.
Equity markets have also benefited considerably from low interest rates as the current climate enables them to restructure borrowings in a way that reduces cost and extends maturity dates, in all leading to a continuing strengthening of balance sheets. Furthermore, companies have been able to adapt current trading to better deal with slowing global activity so that profit and dividend growth have been encouraging. In fact, relative to fixed interest markets, equities offer good value, hence rising values of late.
Among the less favoured sectors, index linked stocks have slipped back slightly as inflation has eased in anticipation of likely changes to the RPI calculation next Spring. The value of well-placed commercial property has stabilised or increased a little although less well favoured property portfolios have not shared in this and metal and mineral prices have declined in anticipation of slower demand.
Before moving on to the outlook, it is appropriate to comment very briefly on moves within the Eurozone so far this year. After much debate and delay, during the Summer, moves to create more powerful Eurozone institutions to oversee budgetary reform and future progress were confirmed. While it is clear that implementation will take time to achieve I believe that the acceptance of the need for such institutions is of paramount importance.
What lies ahead?
I think it right to make a start by looking briefly on what is by a comfortable margin the world’s largest economy, namely the USA. The presidential election will shortly be behind us but, for whoever wins, the first big economic test will be how he deals with the US’s so called “fiscal cliff”. In essence, tax cuts introduced some years ago to stimulate the economy are due to come to an end in January. It is estimated that, should this happen, the resulting contraction in demand will cause the US economy to stop growing and, indeed, to go into reverse gear. I believe it is highly likely that the present tax regime will be very largely extended and the “fiscal cliff” managed in a way that will avoid putting the USA back into recession. In the meantime, the promise of low interest rates and the continuing $40 billion a month of security purchases by the US Federal Reserve to continue “for as long as it takes” will act to support growing employment levels, and it is worth noting that recent US retail sales, the housing market and consumer sentiment reports have all been positive.
In Europe, progress continues in what might be described as a three step forwards followed by two steps backwards fashion and it is highly likely that, in the near future, Spain will formally apply for a rescue package which I believe will be taken as a positive sign as it would be one big step towards clearing the air. What is clear is that overall growth in the Eurozone on any scale will be hard to achieve and I see that the most recent forecast from Germany incorporates a slowdown in growth expectations in 2013. However, within the Eurozone there are many fine companies which continue to take advantage of the Euro’s low valuation in foreign exchange markets and continuing low interest rates so that investment in the Eurozone corporate sector has merit. However, for example, investment in some Eurozone Government fixed interest issues is probably something that many will wish to avoid.
The Chinese economy continues to slow down with latest figures indicating that GDP grew at 7.4% year on year in the third quarter, down from 7.6% previously. In my view the excessive growth levels seen in the last few years are unsustainable, a gradual slow-down is far from bad news and Chinese exports are recently showing signs of growing again as are industrial production and retail sales. While I remain cautious about direct investment into the Chinese equity market, I do believe that its economy will continue to support global GDP growth for the foreseeable future.
At a national level, the UK economy is heavily impacted by developments overseas and the shadow of excess debt, as with many other countries, looms large. However, Sterling remains one of the “safe haven” currencies which have been hugely beneficial over the last couple of years as the Government continues to be able to borrow on extremely favourable terms by historic standards. There is also a thriving market in the UK for both domestic and international corporate fixed interest issues. Companies have continued to report sound profit and positive dividend growth and while it is probable that the rate of dividend growth will slow a little during 2013, after the strong recovery seen in the last couple of years, I do believe that equities continue to offer value as a source of rising income. In the meantime, it remains quite probable that we will see further quantitative easing. On this subject, I considerate it increasingly unlikely that the government stocks that have been purchased from investors by the Bank of England during the QE process will ever return to private ownership. The implication of this is that the QE programme will result in a permanent substantial increase in the money supply, with all of the inflationary implications that this entails. It is my view that this has not yet fully sunk into market thinking, hence my inclusion of an element of index linked investment in many portfolios as an inflation hedge.
Fixed interest investment remains basically sound for income purposes but, given that interest rates cannot fall much further, I feel it would be most unwise for investors to rely on repetition of the capital growth that the fixed interest sector has seen over the last few years. Indeed, there will come a time when, as markets perceive the likelihood of interest rates beginning to return to more normal levels, fixed interest values will look vulnerable. This is not to say that all fixed interest holdings should at some point be sold, particularly where income is required or where it is accruing on a tax free basis (for example, within pre draw down pension funds and within ISAs), but it may be that, if we turn the clock forward 12 months, I will be taking a slightly more cautious view of the sector. Perhaps the reverse is true of the index linked sector, which generally accounts for a smaller portion of portfolios. In the short term, energy and food prices are rising, basic material prices, which have slipped back this year, may begin to rise again if growth in the USA and China is maintained, and, as I mentioned earlier, the full implications of the QE programme on inflation in the USA and in the UK may not have yet been fully understood by markets.
I believe that equities in developed markets do still offer good value in both capital and income production terms. Balance sheets are strong, a key consideration in times that are sometimes volatile and, as I mentioned earlier, the rate of dividend growth may slow down in 2013, I still see developed market equities as a source of income growth in 2013. The more recently emerged, and still emerging, markets continue to hold greater risk which, to an extent, can be mitigated simply by buying developed market equities given that this group conduct an increasingly significant portion of their business in these often lucrative emerging areas. This trend is set to grow, particularly if the Eurozone acts as a drag on global growth, and the huge importance of overseas earnings on, for example, UK companies, should never be underestimated.
Despite a year of relative underperformance, I do consider that a place for commercial property investment remains, particularly in larger portfolios. This sector is of course a global one and from a medium term perspective I perceive good value in some areas.
At the beginning of this newsletter, I mentioned investments with a focus on basic resources, noting that values have slipped back during 2012. I think that perhaps this may be a temporary phenomenon and anticipate the prospects of a return to growing values next year.
Nowhere so far have I mentioned holding cash as a form of defence against uncertainties. While holding an adequate cash reserve is an essential piece of planning, I believe that holding excess cash is an unproductive option.
Reading back through these notes, I feel that the central conclusion is to maintain, or increase, equity weightings relative to fixed interest investment and cash. This theme looks likely to influence my thinking when considering client portfolios for the foreseeable future.
Changes to Annuity Rules
From 21st December this year, annuity rates for males and females are being merged in accordance with the EU Gender Directive under which insurers will not be able to discriminate between the sexes when setting, for example, annuity rates.
The implication of this is that, after the 21st December, annuities taken out by men are likely to fall, possibly by around 10%, as compared with current levels. Men planning to take out annuities in the short term should therefore give serious consideration to bringing this activity forward as a matter of urgency.
It may be worth mentioning that, if in a number of years’ time, interest rates have generally returned to more normal levels, then annuity rates for all are likely to be a good deal higher than those ruling at present so, where the option to defer purchase for some years remains feasible, it might not be appropriate to be drawn into early action because of the forthcoming legislative change.
I would just add that, if you feel that you are affected by this change or if you want to discuss this subject further, it is imperative that you get in touch as soon as possible ahead of the December deadline.
Press Comment on Service Levels
A number of clients have made contact to express concern following recent press reports to the effect that a number of independent advisors plan to cease providing services to clients of relatively modest value, a trend that has been noticeable among the banking community for some years now, where branch based sales teams have been disbanded.
Here at P J Aiken Ltd we operate on a service led, rather than a sales led basis and we have absolutely no intention of withdrawing any of our investment services from our clients.
And finally – The Retail Distribution Review
I have written to you on previous occasions to advise you about the forthcoming Retail Distribution Review (RDR), and what it will mean for you.
The Retail Distribution Review is one of the largest overhauls of financial regulation for more than a quarter of a century. We, at P J Aiken Ltd, want to help you to understand what is happening, how the proposed changes may affect you and why those changes may improve the advice that you receive.
RDR sets out to ensure that as our client you are offered a transparent and fair charging system for the advice that you receive. They want you to be clear about the service that you will receive and that you receive it from highly professional advisers.
The changes required for RDR will come into effect on the 31st December 2012 and will apply to every financial adviser across the retail investment market, including independent financial advisers, wealth managers and stockbrokers as well as banks and other providers of financial products.
The most visible change for many clients of independent financial advisers will be the introduction of fees for financial advice. Historically, financial advisers have relied on commission from product providers when you consult them for advice. The regulators have now taken the view that this could give rise to a conflict of interest as some product providers offer higher commission payments than others for the same product solution. From the 1st January 2013, all financial advisers will have to outline and agree fees for their advice in advance.
All financial advisers in the UK will have to achieve a higher minimum standard of qualification before they are allowed to provide advice. This means an increase in the basic level of knowledge and will lead to a higher level of professionalism for the industry as a whole. They will also have to sign up to an ethical code requiring them to treat you fairly.
RDR has specific rules about how clients should be treated and what information they should receive on an on-going basis. Approved individuals within each advisory company are also legally accountable for ensuring those rules are followed. This will provide you with the added reassurance that our business is being closely monitored within a regulatory framework. In the unlikely event that anything did go wrong, there is both a set process and a chain of personal accountability to ensure things are put right.
In summary, RDR will ensure increased confidence and trust in the advice you will receive from us as you can be certain that it has been recommended to suit your personal circumstances and needs. You will know from the outset exactly what you are paying for and what you expect to receive from us.
Our philosophy has always been to put our clients first with our professionalism and high quality service and will continue to do so in the future.