OVERVIEW
The year got off to a good start with the FTSE 100 share index rising 3.0% in January. However, it was touch and go with the month being quite volatile as markets see-sawed due to concerns about “Grexit”, or the Greek exit from the Eurozone, which would have big implications for a number of major banks in Europe.
The UK and European markets were also supported by thoughts that action by the European Central Bank (ECB) was more likely as prices are now falling across Europe (deflation). This was confirmed near the end of the month when the ECB announced that quantitative easing (QE) was to be introduced across the region. The result was a surge in markets with, for example, the German market gaining nearly 10% over the month.
Meanwhile, Brent crude plunged further in value causing sharp falls in the price of quoted oil companies across the globe. Officials in the United Arab Emirates and Kuwait were cited as saying that prices will only recover when demand improves later this year, with a global supply glut expected to persist into the second half.
As a result of the recent collapse in oil, data showed on Tuesday that consumer-price inflation in the UK slowed more than forecast to just 0.5% in December, its lowest since May 2000. Bank of England governor Mark Carney has said that deflation in Britain is now possible in the near future. Whilst everyone welcomes a cut in petrol prices outright deflation is another issue, as it can result in economic collapse.
Also weighing on sentiment were comments from the World Bank which slashed its growth forecasts for the global economy for this year and the next.
The World Bank now expects 3.0% growth in 2015 and a 3.3% expansion in 2016, compared with previous estimates of 3.4% and 3.5% respectively.
The prospect of deflation boosted the value of fixed-income securities, which surged over the month. Commercial property also put in modest gains, building on what was a vintage year in 2014.
Here is the chart of the FTSE 100 index for the last six months;
…and the last five years, which puts this into perspective;
FUND PERFORMANCE
Short-term Performance
| Parmenion Portfolio/Index | One month
Performance to 31 January 2015 |
One year performance to 31 January 2015 |
| Income Portfolio | +2.7% | +12.5% |
| Average Mixed Investment fund (20-60% shares) | +2.2% | +8.2% |
| Balanced Portfolio | +2.9% | +14.2% |
| Average Mixed Investment fund (40-85% shares) | +2.4% | +9.4% |
| Tactical Portfolio | +3.0% | +14.8% |
| Average Flexible Investment Fund | +2.3% | +9.8% |
| MSCI UK | +2.7% | +7.0% |
| MSCI World (£) | +1.8% | +18.0% |
| IBOX Gilt | +4.9% | +17.8% |
Long-term Performance
| Parmenion Portfolio/Index | Three year performance 31 January 2015 | Five year performance to 31 January 2015 |
| Income Portfolio | +36.3% | +54.9% |
| Average Mixed Investment fund (20-60% shares) | +23.7% | +35.6% |
| Balanced Portfolio | +34.8% | +54.0% |
| Average Mixed Investment fund (40-85% shares) | +31.0% | +46.7% |
| Tactical Portfolio | +37.5% | +57.8% |
| Average Flexible Investment Fund | +30.6% | +46.1% |
| MSCI UK | +32.1% | +54.7% |
| MSCI World (£) | +53.1% | +79.9% |
| IBOX Gilt | +18.0% | +47.7% |
(Source; Parmenion Capital Partners LLP)
PORTFOLIO REVIEW
All Portfolios
Our portfolios turned in decent gains during January as all asset classes made strong gains.
Income Portfolio
The Income portfolio gained +2.7% in January, out-performing its benchmark (the average mixed investment (20-60% shares) fund) which gained +2.2%.
The portfolio benefited from our recent purchase of gilts which surged in value (by around 5.0%). All other investment funds appreciated, resulting in a bumper month for the portfolio.
During the month we trimmed exposure to the UK market and increased exposure to gilts and the US market. Gilts should benefit in a deflationary environment and we like the US$, thinking that the sterling could weaken against the American currency later in the year.
Balanced Portfolio
The Balanced portfolio gained +2.9% in January, out-performing its benchmark (the average mixed investment (40-80% shares) fund) which gained +2.4%.
The portfolio benefited from our recent purchase of gilts which surged in value (by around 5.0%). All other investment funds appreciated, especially our Asian funds, resulting in a bumper month for the portfolio.
During the month we trimmed exposure to the UK market and increased exposure to gilts. Gilts should benefit in a deflationary environment.
Tactical Portfolio
The Tactical portfolio gained +3.0% in January, out-performing its benchmark (the average flexible fund) which gained +2.3%.
Our investments in Europe, Asia and the US market flew and our exposure to European properties generated outstanding gains, with Premier Pan-European property share fund growing by +9.0%.
During the month we trimmed our position in the Japanese market and increased exposure to the US market, thinking that the sterling could weaken against the American currency later in the year.
DEFLATION – WHAT’S THE FUSS?
On the surface, everything getting cheaper sounds like a dream come true. It’s not. The prospect is so terrifying that it’s prompted central bankers around the industrialised world to pour trillions of dollars into their economies to prevent a sustained drop in prices. The European Central Bank has recently acted to try and prevent deflation in the Eurozone.
Here’s why;
- When shoppers see persistent price declines, they hold out on buying things. They ask, will I get a better deal next week, next month, and next year? As a result, consumer spending drops. For most nations, that’s a big chunk of their economy, and any slowdown in consumption threatens growth.
- Businesses behave pretty much the same way. They postpone buying raw materials, hoping to get a break on costs, and delay investing in new plant and machinery or hiring extra staff.
- Additionally, their pricing power — the ability to charge more — vanishes. That makes it harder for them to grow profits. In such an environment, if companies want to grab a bigger market share, they have to slash prices. That makes things worse.
- Lower profits = less money to go around to workers. Employees don’t get the raises they were expecting, they cut back on spending even more, and a vicious cycle commences. That’s why they call it a deflationary spiral.
- Another worrying thing; even when prices are falling, the amount you owe doesn’t. Borrowers get crushed under the weight of that debt. In a mild scenario, companies and consumers hold back on other purchases to continue meeting their obligations. When things get really bad, they go bust altogether.
- Policy makers usually have an antidote to economic slowdowns, but it’s trickier when interest rates are already near zero. That’s exactly the situation with the ECB and much of the industrialized world. That forces officials to turn to unconventional financial tools such as QE.
Policy makers have been raising and lowering interest rates for a long time but quantitative easing – a Japanese invention from the 2,000s – was a relatively untested tool until the credit crunch when the UK, US, Japan and now the ECB have all used it. Its effectiveness is still controversial, but it has boosted asset prices and raised economic growth in the countries where it’s been used.
OUTLOOK for 2015
So, what are the investment runes for 2015?
There’s a lot going on in the world at the moment. Current issues include;
- An increased level of fighting in the Ukraine (tempered by a cease-fire at present);
- Economic weakness in China following a property crash in the country;
- Expectations that interest rates could rise in the US at some point later this year;
- The possibility of “Grexit” (an exit of Greece from the EU).
- The possibility of “Brexit” (a UK exit from Europe after the next General Election).
Any of these issues could cause a market upset. Experience indicates that such things usually pass quickly, but of course, this isn’t necessarily the case. If, for example, the Chinese economy suffers some sort of collapse it will cause a significant set back in markets globally.
However, things are not all gloomy; action by Mario Draghi, President of the European Central Bank (ECB), who has “fired his big bazooka” ignited markets in the Euro region in order to stimulate economic growth here. This has had a positive effect on all the markets in the globe, including the UK, as of course, Europe is our largest trading partner.
Another issue which has affected global markets positively has been the dramatic reduction in the price of oil. A barrel of Brent crude is now trading at around $55 compared with over $120 a year ago. This reduction has caused some market jitters as oil companies around the world are suffering as a result of the fall. However, overall the drop in the price of oil is good news for the global economy as it will stimulate growth everywhere. This is already being seen in many Asian countries where the fall has allowed governments to cut interest rates, an action that always has a positive effect on the markets.
The reduction in oil prices has increased fears of a deflationary spiral emerging, this would be bad if it occurred.
To sum up; we are seeing strong economic growth in the UK and US and the prospect of a pick-up in activity in Europe combined with low inflation globally. This is a good back-drop for all investments, especially income producing assets such as equities that pay good dividends and properties that pay good rents.
Unless disaster strikes we are reasonably confident of a decent year for investors and reckon that the latest round of QE from the ECB will push markets along nicely. We might creep into double digit gains.
Commercial property is now past its best, but it still produces very attractive rental incomes and is less risky than investing in shares. We will remain heavily committed to this market, but will probably start to reduce exposure as the year progresses.
Cash will produce ever poorer returns as interest rates could fall even lower than they are now.
Finally, in order to cover all bases, our lower-risk portfolios now contain gilts. This is a little insurance against that deflationary spiral mentioned earlier taking hold.
We are still able to generate a reasonable income for investors, but it is getting harder and harder. The only comfort we can bring is the observation that for once, living costs are not going up and might even go down a little in 2015.
PS Don’t forget the usual risk warning for all long-term investments; the value of units can fall as well as rise, and past performance is no guarantee of future performance. The value of income payments from investment funds is not guaranteed and can fall as well as rise.
