When will the market recover?
What is your view on the U.S. debt ceiling and its impact on investments as my pensions and ISAs have taken a pounding?
A month or so ago we reiterated the need to be invested in real markets that have exposure to companies with real earnings and real profits, as opposed to the dream values driven by speculative investments. We had originally stated this eighteen months ago when we saw commodities soar once again for absolutely no reason. The entire world was going backwards yet commodities were soaring!
And so Mr Woodford’s high income fund was our port of call for investments due to its exposure to quality companies with cash and value.
It was a big call at the time as it looked like it had underperformed in the previous year but the reality still applied that a beer on a warm day should be more expensive than barbed wire with tinsel on any day. We still believe that strongly.
The issue with the US debt ceiling is just the excuse the hedge fund managers needed to sell markets short. In reality, markets had probably already valued in a downgrade, but it is more likely to have been the signal that has been sent to the market that has driven its downturn.
US sovereign debt was downgraded from AAA to AA+, effectively meaning that the US will pay more for borrowing money than it did before. That will have to be passed onto the US consumer in one way or another as the US government seeks to balance its books.
There were two mains reasons for this: Firstly the US has a rising government debt problem. That debt problem needs to be stabilized. It is strongly believed the $2.1 trillion cut in expenditures over the next ten years will not be enough.
The Democrats and Republicans proved their dysfunctional political processes were…..dysfunctional. This spooked one of the ratings agencies – Standard and Poor’s, who believed that other important items that need action soon, such as entitlements and agreeing on raising revenues would prove just as problematic. S&P’s lost trust in the government as a result.
Learn from the past: There are have been hundreds of recessions and most follow the same principals: Excessive growth of private sector credit or public debt will normally be one of the key drivers prior to any crisis, and that is often followed by excessive growth in money supply and inflation.
Politicians tend to buy their way out of this by either devaluing their currency to make them more competitive, or by spending their way out. This simply transfers the debt from the private sector to the public sector.
Since 2009 US household debt has declined by 10% whilst financial sector debt has decreased 27%. Government debt has soared to 80% of the US Gross domestic product (its economy – GDP). (1)
John Greenwood, chief economist at Invesco points out that the US and European governments have maxed out their credit cards. The above solutions worked in the past because the debt was relatively low in relation to incomes. Because both private and public sector debt is overburdened, the old system is resembling an athlete in treacle with flippers – pointless and energy consuming.
We have been baffled by the press reporting good news about the economy when we are undergoing colossal global cuts. If the money isn’t in the system, how can demand increase and profits rise? Couple this with imported inflation due to exports becoming more expensive through a devalued currency and the economy is faced with less money to recover through the private sector. With potential for falling asset prices (houses etc.) and banks trying to repair their balance sheets, banks are not lending, so syrup is added to the treacle as companies cannot finance their way out of trouble.
This could lead to a further recession as belts are tightened, and it’s hard to see how the US can avoid that. The message from S&P’s is clear – get your finances in order – and the only way left to do that is to cut costs.
Markets will force the Eurozone and the US to cut spending further over the next few months. It’s possible that other rating agencies will follow to down value the US as the plans that are needed to be implemented are in head on conflict with the current president’s views.
Furthermore, in an attempt to stave off inflation emerging economies have also been raising rates, which will slow their growth prospects down.
All that aside, inflation will fall as commodities are dumped. That will benefit US treasuries, and despite the fact we are moving toward a less dominant US economy and dollar, risk averted individuals will still find the currency and bonds as the safer of options relative to others.
Other views:
Jupiter Asset management also report that many companies in the US are in good health with 73% of the S&P 500 reporting better than expected earnings. (2)
Fidelity report that the economy is too weak to suffer any interest rate rises and sites the concern of strained relationships between the US and trading partners like China who are the largest holder of US government bonds. Fidelity rate the downgrade as significant but comment “Good can come from the S&P downgrade, if this humiliation stirs Washington into action.”
Similarly, pre the falls in the market, the price earnings ratio of stocks in the US stood at 13, which is hardly stretched. (3)
In the meantime at Worldwide we advise a defensive approach to investing by buying those stocks and funds with real value contained. As always it will be bumpy and this will be bumpy. History has told us time and time again that overreactions by markets downgrade some stocks to create bargains.
Our advisers are here to help you so please do get in touch. To contact our Northern Ireland office, call 028 6863 2692; our Cornwall office – 01872 222422 and you can reach our Southampton office on 023 8064 9674. If you prefer to email, please contact us on info@wwfp.net.
You can also join our social conversations on Twitter with Peter McGahan and Worldwide Financial Planning and you’ll find us on LinkedIN – Facebook and Instagram