KMG Rebalance October 2022
We are increasing our allocation to cash and reducing allocation to some of our real assets and infrastructure. The justification for this is that we are concerned with liquidity risk within the system particularly within the UK following the problems surrounding pension funds and the potential forced selling of assets by pension funds to meet margin calls. On this basis we have analysed our portfolios and feel it would be a sensible strategy to marginally increase our cash weighting and reduce our exposure in the interim to less liquid investments which primarily includes infrastructure assets.
To put this in context we think there are some key dilemmas in the world that are both positive and negative and your strategy needs to reflect this.
The major dilemma with oil prices around the world is not the supply of oil but the refining capacity and this won’t change anytime soon which is why energy prices which are driven by oil as well as gas will remain elevated.
The strength of the US dollar when converted into local currencies around the world is forcing up the price of debt and therefore making the ability of many countries to service debts very challenging, and only when we see the dollar value declining against other currencies will we see meaningful recovery. In other words, we need a weaker U.S. dollar around the world.
Because India and China are in a different part of the economic cycle to the rest of the world we may see some recovery more quickly in these economies during the course of next year and after the Communist Party Congress later on this month.
There is a worry that Japan which is the biggest holder of US treasuries may have to start selling. The central bank in Japan has been trying to control the yield curve but is coming under increasing pressure and if Japan becomes a forced seller of US treasuries this could have a very interesting and challenging effect upon the global economy.
Estimated underlying inflation in 2023 is predicted as follows:
UK 7%, US 4%, Germany 6%, France 4%, Japan 1%; as most of these are well outside of central bank’s target of 2% inflation we can assume continued central bank aggressive action to raise interest rates to cool inflation in the short term.
At our seminar we mentioned the central bank meeting in Jackson Hole in August and a general consensus in the world that central banks are now withdrawing the position as lender of last resort and forcing governments and politicians to take up the heavy lifting of economic management through fiscal strategy. As the tussle between these two conflicting positions evolves so the global economy will remain very challenged for the next few months.
Wage pressures in the United States suggest incomes increasing by 7%, and in the UK by 4.5% especially whilst job vacancies are so low. Unemployment in the US and the UK is dangerously low. It is estimated that 5 million people in the United States have become economically inactive and 500,000 people in the UK.
To control wage growth unemployment must rise! Central banks are now working directly in opposition to governments as central banks need to raise unemployment to cool economic activity to create a mild recession. So, although this is counterintuitive, it will almost definitely mean that the Conservative Party in the UK loses the next election and the Democrats potentially lose control of the Senate and Congress in two years’ time; even if they don’t do this in November of this year, the reality is that whilst it may be counterintuitive unemployment has to rise for inflation to fall.
The other concentration that central banks have is to cool asset prices to drive down inflation. This can be circumnavigated by investing in the right assets that have to grow in the evolving global economy and we at KMG have to be very careful in our investment strategies to be in the right places that won’t affect the tectonic shifts that are now going on between monetary and fiscal policies.
Growth, growth, growth as the Prime minister suggested in her Conservative Party conference speech is nigh on impossible unless significant change occurs as follows:
Migration improves dramatically and rapidly
Technology evolves dramatically and rapidly but sadly as is demonstrated in Japan where they have continuously had very little migration and massive investment in technology this hasn’t actually created the growth that they have so desperately been trying to achieve for decades.
Although there has been a large amount of loss value seen in government debt and fixed interest funds this year we are now coming to a point where the great sell-off will end and then yields will start to fall again and prices rise. Luckily, we at KMG could see this happening well ahead of most people and moved away from funds that have fallen dramatically which is why your portfolios have held up so well. But we must be alive to the possibility of changing tack in the foreseeable future – but not yet which is why we wish to hold cash.
Mortgage debt remains a significant dilemma especially as a consequence of the UK government’s announcements we may see a two-tier system where mortgage interest rates are kept lower than commercial interest rates. But right now any tax giveaways have been more than absorbed by higher mortgage costs, inflationary costs and energy costs so we can’t see much growth in the UK economy until we know what the supply side reforms to be announced in November may present. What is worrying is the speed at which credit card debt is now growing, particularly in the UK.
The final challenge that is affecting developed economies is not just the mass resignation as mentioned above of people who have simply left the workforce possibly never to return, is the dramatic increase in students who are economically inactive; and perhaps the most worrying is a huge increase in long term sick people who are unable to be economically active. Productivity remains unbelievably challenged while input costs are well above output costs and there is not nearly sufficient investment in machines, technology and mechanisation. Despite what the Prime Minister may say, growth cannot occur until this relationship goes in reverse.
Your KMG strategy balances all of the above. Our view is that the UK dollar exchange rate will probably trade in the region of 110 to 115. Remember that 75% of the FTSE 100 companies’ earnings come from overseas and most importantly the vast majority of your investment portfolio is very globally focused to avoid the vagaries of the UK economy (and in particular inadequate politicians). There is much confusion about growth stocks and value stocks and we continue to hold them all because we think the labelling is unhelpful.
We see little prospect for significant investment returns in the short term, but we remain absolutely convinced that timing the market is impossible and we must just continue to nudge our way through the current period of economic turmoil as we are convinced that better times are not that far away. Keep calm, keep invested and carry on!
Tax
Where changes are made within portfolios there may be some capital gains tax incurred when switching outside a tax-free wrapper. Any changes within the VT KMGIM Medium-High fund will not be taxable.
Fund charges
The fund charges for the portfolios will decrease as a result of these changes, other than the High portfolio which will remain the same. There is no change to the funds fee of the VT KMGIM Medium High fund.