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"If you want things to stay the same, things are going to have to change" (Giuseppi Tomasi di Lampedusa)

21st Dec 2016
by Philip Brown

Well, what a year it’s been! Who would have thought that Ed Balls would go so far in Strictly, or that Candice Brown would win GBBO (surely Andrew Smyth was robbed?), or that nice President Assad could turn out to be not so nice? We’ve had domestic abuse in the Archers for goodness sake and JR Ewing appointed as the new US Secretary of State. There were also some other mild political surprises in 2016; it seems that globalisation is now defunct and populism has taken over the helm. But what’s going to happen in 2017? And how can we use that understanding of the world to our clients’ advantage in their investment portfolios? Read on dear patrons in this final newsletter of 2016.

Firstly, we want to concentrate on two themes that will undoubtedly have a positive impact on our investment funds over the next few years, that is new technology and Asia. An example cited recently by Dr Tony Seba, an academic and leading commentator on the role of technology, tells the story of telecommunications giant AT&T hiring consulting firm McKinsey in the 1980s to forecast the adoption of mobile phones over the next 15 years. McKinsey’s prediction was that there would be a maximum of 900,000 subscribers, but by the year 2000 some 110 million people were using mobile phones. McKinsey’s estimate was off by a factor of 120.

History shows that experts consistently fail to understand the exponential nature of what is known as ‘disruptive technology’ adoption. So our carefully chosen fund managers need to continually identify key technological changes and understand that once adoption begins, it can accelerate very quickly. Identifying new trends is the cornerstone of this process and our managers are today telling us that they are seeing some exciting opportunities in the current emerging group of disruptive technologies. Energy storage technology, smart buildings and smart everything else. The internet of things is coming to a home near you.

One key emerging technology combines cheap solar power and battery storage technology. Even if we ignore the carbon benefits of solar power in the energy grid, the ability for homes to generate enough power for their own needs at a cost which is competitive and does not increase over a 20 year time period is an enticing prospect. The obstacles standing in the way of this goal are increasingly disappearing, with costs of solar technology falling. The economics of the finite fossil fuel industry look increasingly less attractive as the production costs of renewables fall and economies of scale increase. A big limitation of solar energy has been intermittency; the sun shines during the middle of the day but we consume most of our power in the evenings and in the morning. However, the solution to this problem may be around the corner in the form of ever improving battery technology. Home batteries could allow us to store energy during the day, and to use it as we need it in the evening.

The technology behind smart homes and buildings is developing as the next big potential change to everyday life. Just as smart phones took a semi-conductor chip and transformed our mobile phones into a powerful, hand held computer, semi-conductor chips that are integrated into everyday appliances like home refrigerators, office air conditioning and lighting units can transform the way we use energy and cut costs for consumers and businesses alike. This will allow air conditioning systems to connect with lighting systems, for example, to ensure they harmoniously adjust to various different factors such as human occupancy and sunlight levels to ensure no energy is being wasted. Meanwhile your fridge will soon be able to connect to your home energy system to optimise when it draws power to avoid peak energy costs. Good for the planet and good for investors.
The automobile industry has been in the news recently, after the Volkswagen scandal exposed the fault lines in a business model that is struggling to cope with the challenges of disruptive technologies. The irony is that cars were a disruptive technology themselves when they displaced the horse and cart. The industry has struggled to adapt to increasingly stringent environmental standards and the demand for smaller, more efficient vehicles.

The car of the future will be more like a computer on wheels. Tesla is leading the way and has proven that electric cars can make better performance vehicles than those with traditional combustion engines – at the same time as being five times more efficient. Our fund managers generally don’t invest in Tesla at the moment, as they think the shares are overvalued, however they do invest in the companies that are enabling the changes that Tesla has pioneered, in the same way that prudent investors bought shares in the maker of Levi jeans rather than gold mines during the great Klondike gold rush in the 1890s.

This year the biggest companies in the world are as follows:

  • 1.Walmart (US retailer)
  • 2.State Grid (China’s state owned power company)
  • 3.China National Petroleum
  • 4.Sinopec Group (yet another Chinese oil giant)
  • 5.Royal Dutch Shell
  • 6.Exxon Mobil
  • 7.Volkswagen
  • 8.Toyota
  • 9.Apple
  • 10.BP.

This table in 20 years’ time will only look familiar if the above companies can successfully diversify into the new technologies.

Sir John Templeton, the legendary investor once said: “People are always asking me where the outlook is good, but that’s the wrong question. The right question is: where is the outlook most miserable?” Sentiment on Asian equities has certainly been described as miserable of late, after a dismal performance of emerging markets in general and Asia in particular over the past ten years it is understandable that doubts have risen about Asia as an investment case. One can name a litany of Asia’s miseries: debt and lack of transparency in China, concerns about poor corporate governance and corruption and so on. However, according to the Asian Development Bank, Asia’s share of the global economy is set to double to 52% by 2050. By then, Asian citizens will enjoy an income similar to today’s Europeans. In a similar study recently, the International Monetary Fund observed how Asia is set to become an increasingly important component of global economic growth over time. China’s economy is expected to overtake the USA in 2026 and by 2050 the world will be dominated by the trio of China, USA and India, with the rest of the countries far behind.

China is very important for Asia, but Asia is not all about China. We see growth in Asia to be driven by multiple countries, and economists are already forecasting faster growth for countries such as India, Pakistan, Bangladesh, Indonesia, and the Philippines. India, since Modi’s assumption of power, has embarked on a “Make In India” programme that attempts to cultivate domestic manufacturing industries to meet local demands and to provide mass employment. This together with its traditional strength in information technology services and generic medicines is propelling it to exceed China’s pace of growth for the first time in many decades. We expect the higher growth rates in Asia to create tremendous opportunities for our fund managers.

Turning now to 2017, Donald Rumsfeld, the former US defence secretary, once said: "There are known knowns. These are things that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know." We are amazed by how much time and effort people waste trying to guess what will happen in known unknowns. Brexit, China, commodities, interest rates, the oil price, quantitative easing and the US presidential election are all known unknowns. Take the election of Donald Trump: who would feel confident in taking an investment stance based on the outcome of an event that every pollster got wrong?

The problem isn't just that these events are difficult or even impossible to predict. Markets are what are known as "second order" systems: to invest successfully on this basis you would not only have to predict the outcome of the events but would also have to know what the market was expecting and how it would react. Good luck with that. Then there is the problem of the unknown unknowns. The event that may cause a major move in the market may be one that no one has even spotted. It's hard to predict the outcome of something you don't even know exists.

So what should we focus on as your trusted advisers? We would suggest just three things. First and foremost holding a well-diversified portfolio containing several different types of asset, such as UK blue chip shares, overseas companies that are performing well with plenty of cash on their balance sheets, specialist funds investing in smaller companies or rapidly growing technology firms, government bonds issued by reputable countries, commodities (gold, oil etc.), commercial property, emerging markets and so on. Since all the money in the world has to flow somewhere, if we do this we can’t ever be absolutely wrong. Avoiding capital losses is half the battle, as well as keeping us popular with our highly esteemed clients.

Secondly, we make sure on your behalf that, when our fund managers do buy shares, they invest in great businesses. These are not as difficult to identify as you might imagine, having typically been around for ages and produced good financial results by providing products and services that customers want. The average company in one of our client portfolios was founded about 50 years ago. Having survived this long they will probably survive whatever known or unknown unknowns lie ahead.

Thirdly, take a long term view. Ignore the widescreen TV in your lounge showing the same Sky rolling news every 15 minutes. If you are a long term investor, all that short term stuff really doesn’t matter. If you don’t believe us, take a look at the table below which shows how consistent global economic growth has been since the 1980s.

Source: Haver Analytics, Sept 2016.

In terms of economic reality, which is often quite different to how the markets behave, several clients have asked us recently about inflation and how this might affect their investments. We believe that inflation is set to rise next year, maybe up to 4% by the end of 2017. Brexit has actually pushed the UK to the front of the global inflation queue by its devaluation of sterling. Also, the new Chancellor Philip Hammond has effectively altered course to go from austerity to an anti-austerity government overnight. The extra government spending is bound to add to price rises. We don’t think that inflation will get out of control though; ultimately this is a deflationary world because of the debt burden carried by many countries and consumers. There is no huge wage pressure either on account of new technology being introduced to replace or at least supplement humans in the workplace.

Overall we expect the long post-crisis economic recovery to continue in 2017. Economic growth should broaden out to more countries, with the global economy drawing on more sources of strength than at any point since 2010. Populism is challenging globalism and creating new risks. Concerns about low growth are giving way to concerns about inflation. Years of focus on monetary policy (interest rates and money printing) are giving way to a close watch over fiscal policy (tax and spending). The balance and composition of President Trump’s policy agenda between stimulating the US economy, free trade, immigration and foreign policy is still largely unknown and hard to generalise, which therefore leads to a wide range of possible economic and market outcomes. Transition will be the name of the game in 2017. But what we do know for sure is that uncertainty often generates some great investment opportunities. We remain confident that your investment portfolio will continue to perform creditably over the coming months and years.

Penultimately, next year we intend to set up some kind of charitable foundation where we will donate a percentage of our profits each year to worthy causes (Steady on! Ed). Ideally we want to concentrate on small gifts in the region of £500 each where the money will make a big difference to someone. Perhaps our clients may have some ideas for us to consider?

Finally, we would like to take this opportunity to thank all our clients most sincerely for your continued support and friendship in 2016. Please accept our very best wishes to you and your families for the holiday festivities and the New Year ahead. Don’t worry, it will soon be Boxing Day. 

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