As things stand now, it might seem that there is no light at the end of the tunnel - in investment terms at any rate. American government debt has been downgraded, the euro zone is about to go into its second recession in five years, the US’s fragile recovery is in serious danger of stalling and China’s transition to a more balanced, consumption-led economy is more than challenging its double-digit growth history. Given this environment, why would anybody want to buy equities? After all, globally equities lost 40% in 2008, and whilst this has been recovered to a large degree, it has taken five years to do so! Japan has never even come close to revisiting the heady heights of the Nikkei in 1989. This option does not really seem like a great source of stable, inflation beating returns does it?
For those of us from a Judeo-Christian heritage, it is sometimes possible to believe that suffering is worthwhile; a way of paying for past sins. In this light, the age of austerity in which we supposedly live has a sort of redemptive quality. Grit our teeth, and we will come out the other side, purified and ready for robust economic recovery.
As many readers will know, MitonOptimal are our preferred fund house. Their common sense approach beats all others as far as we are concerned. For example, their strategic inflation forecasts are based on the long term Kondratieff inflation / deflation / disinflation cycles. The developed world has been in the disinflationary and deflationary cycle since 1980 and is about to change to a vastly different long inflationary period. Most Emerging Markets are earlier in this cycle with some Asian countries ahead of the process.
Anyone who had listened to what the Bank for International Settlements was saying since 2005 would have been well prepared for the shocks that began towards the end of 2007 and then blew up in 2008. They issued a new warning in their September 2011 report, The Real Effects of Debt. We should heed this warning. They conclude, “Our examination of debt and economic activity in industrial countries leads us to conclude that there is a clear linkage: high debt is bad for growth. When public debt is in a range of 85% of GDP, further increases in debt may begin to have a significant impact on growth (in 1st qtr 2010 USA’s debt: GDP ratio was 117%)… A clear implication of these results is that debt problems facing advanced economies are even worse than we thought. Given the benefits that governments have promised to their populations, ageing will sharply raise public debt to much higher levels in the next few decades. At the same time, ageing may reduce future growth and may raise interest rates, further undermining debt sustainability.
The Bank of International Settlements (BIS) analyses a country’s debt by three categories - corporate, government and household. The BIS did a report in September which showed that there were thirteen countries in the developed world whose debt was beyond the threshold in at least two of the aforementioned categories. Time was when markets could just worry about one or two countries. Unfortunately, with the world edging towards a financial precipice, those markets are now going to have to concentrate on many more nations than usual as the numbers are just too large to contemplate.
Anyone who knows this film will remember it is about a thief who dies on his way to collect loot he hid years ago. He reveals where it is to a group of people who cannot agree on how it should be split and so go after it themselves - individual selfishness and greed rather than the collective good.
As part of the Chinese proverb says, we live in “interesting times”. My business partner, Paul Gambles has a regular spot on CNBC and was speaking recently about currency fluctuations and investment on the TV Channel.
So why should investors invest in small cap shares, especially those in the riskier area of the market, namely emerging markets?
Most anthropological research data and psychological or behavioural studies tend to reinforce the idea that human activity always has resulted and probably always will result in there being leaders and followers or hunters and gatherers or Alphas and the rest of the pack. These universal human instincts can be seen everywhere from the rough and tumble of school playgrounds to the benches of the House of Commons or the Senate to the stock market trading floor (although all too often those environments can sometimes resemble each other).
The other alternative is to identify assets with similar investment characteristics to cash but which produce higher returns. Asset-backed investments generally provide a reasonable level of security depending on the underlying assets in question although in many cases liquidity is compromised.