"One abiding impression I take away from this year is that of conventional wisdom unravelling"by Andy Davis / December 10, 2015 / Leave a comment
Sometime between Christmas and New Year I always sneak an hour or so at my desk to work out how my efforts have turned out over the previous 12 months, and to think about the lessons I should try to remember for the year ahead. With the end of 2015 in sight, it’s already obvious that the imminent reckoning is going to be pretty uncomfortable.
I deliberately restrict myself to relatively few holdings because I don’t have enough time to keep up with the news from a large number of companies. Perhaps, if I ever get to retire, this will change, but for now needs must. Having a concentrated portfolio cuts both ways. When things are going reasonably well, it makes my kind of investing manageable in the time I can give it and means that I have a large exposure to prices that are rising. When, as this year, things are much more mixed it means that losses hit you hard and the pain of them is keenly felt. The particularly painful story recently has been the hit I took on one large and longstanding holding that fell victim to something I’ve observed from a safer distance numerous times during 2015: the swift and brutal reaction of share prices—even among the largest companies—to relatively small pieces of disappointing corporate news.
With the benefit of hindsight, I suspect a range of factors have been at play this year that conspired to make setbacks like these larger and more frequent. It’s been a nervy year for investors, with a general feeling that trading conditions for a lot of companies remain a bit of a slog. Confidence in 2015 has been brittle—hence the big falls after minor setbacks—and scandals like the one that hit Volkswagen in September were a stern reminder of how hard it is ever to know what is really going on inside the companies we invest in.
One abiding impression I take away from this year is that of conventional wisdom unravelling as the wind changes direction. Among the ideas that have crumbled in 2015 are that China will remain the dynamo that can offset weak growth across the rest of the world economy; and the more general notion that reasonably robust growth in emerging markets (much of which depended directly or indirectly on Chinese demand) can be safely taken for granted. The most obvious victims of this reverse are the major mining and oil companies that make up such a large proportion of the UK’s FTSE 100 Index. They have been particularly hard hit by the realisation that if Chinese growth—and especially its construction boom—is slowing down, there will be far less demand for the materials they spend billions extracting from the earth. These companies have borrowed gargantuan sums to build mines and drill wells. Once they have finished slimming down and shedding debt, the current down-cycle will eventually turn, but there is not much sign of that yet and the wait could be a good bit longer.
For some years now, there has been regular talk of “currency wars,” in which countries try to bolster their own competitiveness by allowing their currency to devalue relative to major trading partners. In 2015, however, we also saw “resource wars,” for example Saudi Arabia’s decision not to cut its oil production, even after prices halved, in order to try to force higher-cost producers out of the market. This aggressive stance is helpful to oil consumers because a big drop in the price of oil acts, we are told, like a tax cut that leaves people with more disposable income. However, on the other side of this coin, the downward pressure that the falling cost of oil exerts on prices more generally makes it harder for a lot of companies to charge more for their goods and services. Therefore anything beyond very modest growth in revenues becomes extremely hard to achieve: this is not an environment in which many shares will do well, while those rare exceptions that can tell a compelling growth story become very highly sought after and uncomfortably expensive.
A combination of diminished pricing power for companies across the developed world and a gradual draining away of confidence in the emerging markets growth story has left many investors, myself included, feeling confused and exposed. For the past 15 years and more, major companies have pointed to long-term growth in demand from emerging markets as the key reason to own their shares. Assumptions like this are now open to serious question and as a result the case for investing in businesses ranging from luxury goods houses, to retailers, car companies and even makers of industrial machine tools, needs to be re-examined and made afresh. Back in 2001, Goldman Sachs coined the term “Brics” (an acronym comprising Brazil, Russia, India and China) as shorthand for the idea that large, emerging markets were set for decades of strong growth. Towards the end of 2015, in a telling sign of the times, Goldman rolled its Bric fund into a wider emerging market vehicle due to dwindling investor interest.
As the year draws to a close the outlook is foggy. The stories that we have relied on to explain the investment world have lost much of their power to convince and we await a new narrative that will give us a credible reason to buy. I suspect some brave souls prepared to take a chance on the major commodity producers might feel pretty clever a few years from now, but only if they are prepared to run a very large risk of feeling profoundly stupid first.
One investment story that has remained stubbornly intact through this tricky year has been that old favourite, the housing market. This is the asset that British savers and investors trust above all others and their love for it knows no bounds: recent research from the Office for National Statistics showed that 44 per cent of those questioned thought property would make the most of their money for retirement. Just 25 per cent thought a workplace pension would, although when asked which was the safest way to save those proportions flipped. Not surprisingly, shares in housebuilders are up very strongly indeed over the past five years—helped by the government’s Help to Buy announcements since 2013—and especially since the beginning of this year. At the same time, buy-to-let mortgage lending is surging, prompting the Bank of England to voice concerns about financial stability should property prices suffer a knock.
This is one narrative that does make sense to me. Ultra-low borrowing rates continue to make mortgages for those that can get them look a compelling proposition and therefore underpin property prices—one of the more convincing pieces of research I saw this year argued that borrowing rates have a much bigger influence on property prices than does the supply of property for sale. I buy that story.
By the same token, ultra-low savings rates make finding somewhere worthwhile to park your cash harder than ever. The previously simple act of saving, which we are all told we must become better at, is now a major challenge and also extraordinarily unrewarding, although the government at last appears to be taking some steps to tackle this problem. I’m looking forward to the launch of the new Innovative Finance ISA, I hope next April, with great interest. The opportunity to take tax-free returns from Peer-to-Peer lending, which range from 4 per cent to 10 per cent-plus depending on your risk appetite, is one bright spot for frustrated savers although I have heard nothing yet on what the charges will be to run one of these ISAs.
I am also going to venture back into pension saving before the end of this tax year via a Self-Invested Personal Pension. I gave up on the idea of making further contributions when I became self-employed because I could not stomach the idea of being forced to use the money to buy a horribly unattractive annuity. Under the new freedoms that went live last April, pension saving looks like a sensible option again and I plan to resume.
How far I go will depends, however, on the next chapter in another story that has dominated 2015: the permanent revolution in the British pension system. I am strongly in favour of the changes the government has announced since the 2014 Budget and I also agree that higher-rate tax relief on pension contributions should be abolished to save money and tilt the system to help on those on lower incomes. But I will tread cautiously as long as the possibility remains that the Chancellor, George Osborne, will turn the entire set-up on its head and abolish tax relief altogether in favour of a “Pension ISA” that has no tax break when money goes in but levies no tax when it comes out. Anecdotal evidence suggests that, Osborne aside, there is very little support for this idea in the Treasury so I live in hope that it will end up in the basket marked “Nice Idea But I Wouldn’t Start From Here.”
I guess that given my difficulty in reading the conditions in financial markets, I could say the same of my plan to venture back into pension saving. It’s a fair point; I shall do so as carefully as I can, endeavouring to apply the lessons of 2015 rather than becoming paralysed by them. I wish all my fellow DIY investors a happy and prosperous 2016.