We thought we would do a roundup of our portfolio returns after the New Year, when we have the full figures. In the meantime, I noted the last update had no pictures, so to make it easy this week as we prepare for the festive break, I thought I would go for my charts of the last few days and weeks.

Quantitative easing versus asset prices

The chart below shows the size of the US Federal Reserve (the Fed) balance sheet versus the main US equity index the S&P 500.

                       

 

Current Market Valuation

This is not so much about interest rates but the extent to which the Fed was buying bonds onto its balance sheet, the process known as quantitative easing or QE. The correlation between the lines is clear, asset prices generally, and share prices in particular, rose as the Fed balance sheet expanded. Having stopped the QE process this year, and even attempted to reverse it, asset prices have been falling and interest rates have been on the rise.

The interesting bit for me is the Covid effect. Whilst QE began after the financial crisis you can see how it stopped and was even being reversed in 2018 and 19. Then came the lockdowns. From early 2020 you can see the extent of the Feds activity to prop up the economy through the lockdowns, which surpassed the post financial crisis effort and its effect on the equity index.

We are blessed at Tideway to have some highly experienced investment professionals as clients and one of our advisers was talking to one who is the head of investments at a well-known insurance company who said he could see the S&P 500 index going down to 3,000. This is another 20% below where we are today, which is already 20% off the peak. This may seem like a very bearish call, but as can be seen from the chart it could be correct if the post covid rally was mostly a function of QE and speculation rather than real growth in company earnings and fortunes, which sounds pretty sensible to me.

Of course, we don’t invest in this index or any other right now and parts of the stock market are doing a good deal better than the index.

Even Japan looks like joining In

In a recent note we highlighted Japan as the only developed market not to raise interest rates and this week they did.                         

 

Higher rates are here, and we think for some time to come. This interest rate increase is helping the Japanese Yen which had been the weakest currency against the US dollar and it has recovered around 10% in the last month and half.

House prices

We mentioned house prices in the last update as an area that could create further pain. The jump in rates takes a while to feed into prices. In the UK we have a chronic shortage of housing, and this will no doubt underpin prices, especially outside London where they were less elevated. London house prices have been falling in real terms now for several years. I have first-hand experience of this.

Elsewhere in the world where supply is less constrained, prices are also now falling. North America in particular has already recorded significant drops after big gains in recent years, which now look out of line with higher rates. Forecasts are for further drops to follow.

       

Macrobod, ING

Pound vs Dollar

We try and avoid speculation as much as possible and speculating on currency movements is notoriously difficult, but of course currency movments have a big impact on investment returns when you start to invest internationally. It is the pound versus the dollar which has the biggest impact as the majority of international investment assets are priced in dollars.

 

Pound Vs Dollar Last 50 Years                      

Macrotrends

It has very much been one way traffic since the financial crisis with an almost 50% peak to trough fall 2007 through to the Autum this year that added 3.3% a year to returns for UK investors in US assets. No wonder the West End is full of Americans doing their Xmas shopping!

It has not always been like that. As can be seen between 1984 and 1990 the reverse happned with a 100% gain in the buying power of pounds to dollars. I’m not saying that will happen again but if you are spending pounds it’s a big risk to have most of your investment in US dollars at this level. In the last three months we have seen a reversal in longer term interest rates which are now marginally higher in the UK than the US. As with the Japan move, currency values move predominently with interest rates and as rates in the US and UK level up you would expect a recovery in the exchange rate.

I noted this morning that Hargreaves Lansdown have just launched a US Equity fund which raised £600m from retail investors. We should always remember that past performance is no guarantee of future returns. If our client is correct on his S&P 500 call and the Pound continues to strengthen against the dollar these investors could be nursing some big losses next year. As those who have been in our industry a while will know this will not be the first big retail investment launch into a falling market based on past returns.

It is still a long way down for some investors

As you know I always like to give Elon a mention though I’m not sure he needs the publicity, he has been getting rather a lot of late.                        

Yahoo Finance

For those who saw the charts on Peloton earlier in the year you will start to see the resemblance. The ‘price discovery’ (that’s the term used to avoid words like fall, collapse, or haemorrhaging losses) is just taking a little longer with Tesla. The point here is that as a car company in an extremely competitive market, Tesla is still worth $395bn.

Although that is now 30% less than when I mentioned Tesla shares two weeks ago and noted the continuing downward trend, it is still roughly three times the price of Mercedes, Ford and General Motors combined. Having already fallen 65%, it could still fall by the same amount again and be worth what it was valued at in early 2020 before Covid hit and QE followed.

By my calculation Tesla and Amazon shares have destroyed around $1.7 trillion of paper wealth in the last 12 months equivalent to about 50% of the UKs National debt. Some people must be looking forward to a less prosperous New Year!

Happy Christmas!

To say 2022 has been a tough year for investors is an understatement with most major asset classes down meaningfully with only a select few surviving completely unscathed; we were no different. We will save our analysis of portfolio performance, for our quarterly portfolio commentary which will be available on the portal, as part of your valuation pack, in early January. Today we will instead focus on asset allocation and how we are currently thinking about portfolios.

Asset Allocation:

• • Fixed Income: Preference for fixed income over equities at this juncture believing they are more accurately pricing in the global recession to come. Being higher up the capital structure, we are better protected should markets continue to be volatile, harvesting the healthy yields on offer while we wait. Rates will not rise to the same magnitude in 2022 which was one of the worst years on record for corporate bonds.

• • Equites: Have already seen their valuations (Price to Earnings ratios) decrease dramatically. Although earnings have held up better than expected this year, we are still worried about downgrades early next year as the effects of higher rates on company operational performance are realised. Over a long-term view, still very likely to outperform fixed income and will always maintain a healthy structural allocation. We may look to add on any further weakness.

• • Alternatives: Maintain a steady allocation to long term structural themes such as infrastructure development, renewables and urbanisation whilst holding an allocation to absolute return as portfolio insurance.

• • Cash: As ever we remain fully invested, as we don’t believe anyone can consistently time markets. We don’t want to be caught with too much cash when markets recover. Markets will likely react quickly to any positive news.

Fixed Income:

• • Despite rising yields, we still prefer corporates over governments though won’t rule out a future investment if corporate spreads tighten. Currently being appropriately paid to take credit risk, especially at the short end of the curve.

• • Within credit our preference is for the Investment Grade and the higher quality end of the High Yield market (BBB and BB in rating agency language). At the lower rated end of the market we rely on managers to do the appropriate work, identifying mispriced securities which are not realistically at risk of default.

• • In the High yield market, we prefer to stay short duration as this reduces Credit risk and therefore volatility. More generally we hold a mixture of shorter and longer duration strategies with the shorter duration strategies designed to help protect against any further rate rises which are not already priced in. Being paid handsomely to wait at the short end with the yield curve in the US and UK currently inverted. There will be a time to extend duration next year

• • Overweight subordinated and financials – Banks and Insurance companies were the victim of the last financial crisis. They are unlikely to be again as they are much better capitalised than last time around whilst offering premium yields in the subordinated space. Spreads will still be volatile, but we feel comfortable with the risks from large and well capitalised investment grade issues.

• • Preference for developed markets with majority of our managers being diversified globally

Alternatives:

• • We continue to take a diversified approach in this space combining a mixture of Real Assets, Multi-Asset and absolute return fund strategies.

• • Long term secular growth stories in infrastructure, renewables and property with high yields.

• • Trimmed our allocation to property earlier this year in the face of rising rates (typically bad for REITs) though believe valuations are now at much more attractive levels. Diversified from a sector perspective.

• • In the multi-strategy department, equity allocation is close to all-time lows with the opportunity coming from their Short-Dated Credit book and their exposure to Real Asset projects which sold off in the second half of the year

• • Our allocation to absolute return has performed its role well in portfolios this year, both holding its value and proving to have very little correlation to our other investments. We will continue to hold through the cycle providing portfolio insurance in times of market stress whilst also providing stable returns in more bullish markets.

Equities:

• • Retain a balanced split between value, and growth styles with a strong underpin from cashflow generating and income-yielding securities. Although we have added more value exposure this year, we believe it is prudent to continue to spread our bets and remain both stylistically and geographically diversified.

• • This being said, we believe the playbook for Equities has changed materially and prefer tangible assets over intangible assets which have been the strongest performers over the last decade. We are very sceptical of that more speculative higher growth names without strong fundamentals will ever recover to previous trading levels and the market as a whole will continue to trade on lower valuations relative to their earnings.

• • Dividend yield and dividend growth will form a much larger part of total return going forward with investors no longer able to rely on revaluation alone to drive portfolio returns.

• • GBP portfolio returns driven by the perpetually strong dollar are also unlikely to provide the same tailwinds.

• • All this points towards being more selective in Equity markets with pockets of value to be found for the active investor. More importantly perhaps it is the companies not selected by our managers which will help drive returns. We believe weaker companies with poor balance sheets will be found out as they both continue to feel the effects of sustained higher inflation and rising rates, with the latter also causing problems when it comes to refinancing their debt stack. Despite index funds doing very well over the last 10 years, we do not think passive solutions deserve consideration, in this new environment, over quality active managers performing fundamental analysis on all the companies hold.

• • Geographically, we remain globally diversified with a core of Global managers with individual country strategies around the edges to tweak overall allocations. Using global mandates gives the manager the widest possible opportunity set with which to implement their investment strategy whether that is Value, Dividend Growth or investing for income.

• • Versus the IA Global sector, we are underweight the US, with a slight overweight UK & Europe and an overweight position in Asia Pac/ EM. Our Asia Pacific position is more heavily focused in developed nations with Australia in particular well represented.

• The content of this document is for information purposes only and should not be construed as financial advice
• Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise
• We always recommend that you seek professional regulated financial advice before investing