Norwich Independent Financial Adviser looks at the state of the markets

• Author: Alan Boswell Group
• Published: 18/11/2008

Is it as bad as it seems? It might seem a simple question by which the media chooses to influence the public at large. The answer, as ever, is that it is not simple. Where previously an economy was governed by its own fortunes to a degree, the world has become so integrated that national governments do not always have the influence that one might expect.

Having seen the first black US president-elect voted in to office, financial markets reacted positively but have since returned to their more sombre mood given the effects of the credit crunch generally on industrial activity both in the US and overseas. There is much to be done to encourage a more benign environment in which businesses and consumers can operate.

Doubtless, some clients will know of someone going through the difficulty of resolving their cash position with an Icelandic bank that has been placed into administration. In this regard, the UK Government and its agencies have acted in a decisive fashion to try and prevent any issues similar to that caused with Northern Rock. To an extent, the decision to allow Santander to buy Alliance & Leicester along with Bradford & Bingley and the potential Lloyds TSB/HBOS deal brings some respite and places the UK Government in a stronger position to influence banking culture going forward. Nonetheless, vigilance should be paramount for customers with deposits over the protection level of £50,000 in some offshore jurisdictions.

Whilst all news seems gloomy, many companies are still reporting strong profits, even if not an excessive level of profitability, and one should not forget that many every day activities must still be undertaken by consumers and businesses. Despite suggestions in press reports of unemployment reaching 3 million by the end of 2009, there is a risk of talking ourselves into a weaker position than may actually be the case. Those companies producing goods and services needed by both private and business consumers will still trade. Those weaker firms will merge with larger entities where value continues to exist and there may well be a case to suggest that value anomalies can be exploited by investors over the coming two to three years.

Sentiment continues to dominate market moves, and there is no reason to suppose this will reduce pricing volatility at any point in the near future. For long term investors the price anomalies can present interesting investment opportunities for fund managers to pick up undervalued assets with a view to an increase in values when the economic news improves.

Inflation

The newspaper headlines of a cut in base rates to 3% (the lowest since 1954) suggest inflation may be easing faster than expected. The latest Bank of England data suggest that the outlook for economic growth during 2009 may well be around -2%, with inflation rates of sub 2% during the same period. Undoubtedly good news in some respects, but the report does suggest that an economic contraction will happen during 2009. Currently UK inflation has fallen from recent highs: using the government's Consumer Prices Index measure (CPI) it is 4.5% ; however, the Retail Prices Index (RPIX) rate is 4.7% and there is a continued suggestion by some consumers that retired people feel the effects of 7-8% inflation as they buy a different basket of goods and services. UK interest rates are currently being held at 3% with the prospect of some further easing. Inter-bank lending rates are still higher but are falling to reflect increased liquidity and reduced lending pressure, indicators which suggest a slowdown may be imminent. Of course, reduced interest rates mean lower real returns after inflation and higher costs of debt servicing. Investors should therefore consider the position of their portfolios if they are looking for income generation in future and reduce any debt levels as appropriate to their circumstances.

Commodities and Property

Whilst slowing growth might seem negative for all concerned, investors should be in no doubt that those assets which waste: ie they are used once and consumed for all time, still have much value. Commodities and property will undoubtedly return to vogue in the future as, to quote Mark Twain; 'they don't make land any more'.

This could apply equally to precious metals and to some extent agricultural commodities where consumption is only likely to increase over time. Volatility in pricing remains high (although oil has fallen from $147 per barrel to its current $51.66 ) with property falling commensurately in many markets to reflect the economy at large.

It should remain in a more balanced portfolio however, due to its lower correlation to other financial assets. Indeed, it might reasonably be argued that exposure should be relatively high given the fixed availability of some particular commodities. Given the volatility in pricing though, each individual should weigh up the arguments before investing. With assets such as property being difficult to sell, it shows the benefit of the need to consider it a long term investment. Much of the future growth being likely to come from rental increases rather than pure capital growth. Borrowing costs and bank liquidity remain a key constraint in the use of this asset class as an investment.

Index Linked

A recent area of popularity: with the fall in inflation and reductions in interest rates, these assets have less relative attraction recently. They still provide protection against inflation but less so as the level falls away. They can act as a balance in a more equity biased portfolio, but better value may now be appearing in some other fixed interest areas such as selected corporate bonds. Many of our fund management partners are now beginning to suggest value is occurring here. They are effectively loans provided by investors to a company for which they receive a distribution regularly in the form of interest on that loan. Should interest rates fall sufficiently, these income streams become more valuable and given this fact, the bonds themselves actually increase in capital value as well as providing the regular income. Many of the funds we have recommended to our clients in the past will have at least some exposure to this asset class for the benefit of investors and given income yields of between 6-11% in some cases, they should be explored further by investors looking for exposure.

Opportunities

All around may appear gloomy but it would be wise to consider this parable regarding long term investment:

At age 15, this young man bought a pinball machine and placed it into a local barber shop. He made $4 per week on his $25 investment. Whilst at school he used this business to buy 40 acres of land and a farm and put himself through college. At 25 he started an investment partnership with $100k of family money. An initial $10k investment would have been transformed into $267k after 13 years of investing. Rolling over your original $10k investment into his new investment vehicle would have increased to $5m after investing for 30yrs to 1986 . And now? Considerably more obviously. The young man? Warren Buffett. The message? Investing to grow wealth is a patient game. A recent purchase? $5bn of Goldman Sachs stock; suggesting that perhaps value is emerging and we should all consider this despite the gloom and general air of panic that pervades.

Summary

Investors and policy holders should be mindful of the current economic situation but, where appropriate, continue with the strategy they have selected in tandem with their adviser. Strategies either for capital growth by investing some capital in real assets (that is equities, commodities, other securities), some shorter term protection in the form of cash or the equivalent and some in other less correlated assets such as property (both directly and indirectly) and other structured products with an absolute return mandate will continue to bear fruit over the medium term. Identifying the correct product type, and using our favoured access method for investors via a multi manager approach (which by definition will offer a multi asset exposure to underlying investments), will in all likelihood result in clients who can follow an investment approach with more clarity and understanding in the process used. This should help engender the confidence that is understandably lacking given present market conditions.

Please be assured, we retain an open mind should any client wish to reconsider their approach to their financial planning and should you wish to discuss any of the issues noted above, or have any questions about multi manager/multi asset investing as part of your financial planning, please contact your adviser directly who will be pleased to offer guidance.