Which global themes will lead investing over the next decade?
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Fiscal challenges: Playing the long game Now
Which global themes will lead investing over the next decade?
Your money behaviour - avoiding the traps
Going guarantor - be aware of the risks
By Bevan Graham, Chief Economist, AXA Global Investors
In the past we have commented on the importance of bringing fiscal policy (the use of government spending and revenue collection to influence the economy) back to a sustainable path so that we can get back to worrying about the old problems of an aging population, the rising cost of healthcare and state-funded retirement incomes.
Two recent papers, one from the IMF (A Strategy for Renormalising Fiscal and Monetary Policies in Advanced Economies, IMF Staff Position Note, September 2009) and the other from the New Zealand Treasury (Challenges and Choices, New Zealand’s Long-term Fiscal Statement, The New Zealand Treasury, October 2009) have done nothing to alleviate our concerns.
Fiscal policy BC (Before the crisis)
Even before the Global Financial Crisis (GFC), many countries, mostly developed, were facing growing fiscal challenges. This was most notably from the aging of the baby-boomer generation. This was projected to lead to an increase in the proportion of the population in retirement, and therefore a decrease in the proportion of the population in productive employment.
This would, in turn, put pressure on the (relatively) smaller tax-base to fund the growing costs of healthcare, education, infrastructure and retirement incomes. A “no policy change” scenario would see growing budget deficits into the future and rising public debt ratios.
That was then, this is now
A lot has changed in the last 12 months. A deep and synchronised global recession has been met with expansionary fiscal policies introduced (amongst other measures) to support aggregate demand to prevent a collapse of the global economy into a deflationary spiral.
As we said at the time – that was the correct short-term response, but it was never going to be the long-term solution.
That means that right here right now, the starting point for assessing our ability to cope with the longer term fiscal challenges is considerably more challenging with lower fiscal balances and higher public debt.
So while 12 months ago it looked like we had time to assess the policy responses to the longer term challenges of fiscal sustainability, the lower starting point means the timeframe has shortened-up considerably.
What to do, what to do…?
The IMF research shows that for advanced economies (what we call developed) on average, to get the debt to GDP ratio down to 60% within the next two decades requires steadily improving the cyclically adjusted primary fiscal balance. This would require shifting from a deficit of 3.5% of GDP in 2010 to a surplus of 4.5% in 2020 (an 8% adjustment!!) and then keeping it there for the following 10 years. This is a huge ask.
As the IMF points out, not renewing the fiscal stimulus gets us part way there, but only by about 1.5%, or less than a quarter of the 8% shift required. The job ahead is still immense. Importantly, it is unlikely that economic growth will do the job by itself. That means serious fiscal reform is ahead, and the earlier we start, the less dramatic that reform will need to be.
This will mean looking at things like the costs of healthcare, pension entitlements, and how governments fund infrastructure.
The risks of doing nothing are as equally immense as the challenges of trying to fix the problem. Persistently higher debt levels means higher interest rates (and a vicious cycle of higher interest costs leading to higher deficits leading to higher debt leading to higher interest costs…) and less ability to cope with future economic shocks. In the recent GFC, the private sector was bailed out by the public sector. Who bails out the public sector?
The New Zealand case
In its 2006 long-term projections, the Treasury projected net public debt would get to 100% of GDP in 2050. With the new lower starting point for operating balances, that is now projected to be 220% of GDP.
That will not happen. The question is what needs to change so that it doesn’t happen. Stronger economic growth is an obvious answer, but will be hard to achieve.
There needs to be some serious thinking followed by serious action about reining in fiscal expenditure. This will mean addressing costs in the public sector, but also entitlements, such as superannuation.
Fiscal options AD (Avoiding Debt)
The Treasury outlines some broad principles that must be followed in setting policy. The most compelling ones for us is that:
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Early change will be easier than later change. Simple mathematics tells us that the earlier we make the changes, the less dramatic those changes need to be.
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Focus on economic growth.
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Keep spending and entitlements under control. Over the last few years we have had a tendency to extend entitlements that are hugely expensive (such as Working for Families). Middle-class welfare is not affordable (and neither is it desirable even if we could afford it).
Conclusions and implications
Exit strategies from the current stimulatory fiscal conditions are not just important in terms of the
medium-term inflation outlook, but also from a long term fiscal sustainability perspective.
Bond yields globally are heading higher as deficit countries look to fund what may now be large long-term deficit positions. This will crowd out private sector investment and supports the case for a period of subdued economic growth from developed countries.
While deficit countries previously had time to consider their responses to future fiscal challenges, that time frame has now shortened considerably given the lower operating balance and higher debt starting points. Action to address long-term fiscal challenges is needed now.
Out of adversity comes opportunity. The case for infrastructure and a greater role for the private sector to drive strong commercial disciplines within the sector was a compelling factor in the establishment of our Global Infrastructure Fund.
Which global themes will lead investing over the next decade?
From Spicers Portfolio Management
Recent economic events have presented investors with new insights and opportunities while also reminding them about the timeless truths of how to invest prudently.
There’s no arguing that today’s world is changing fast. The global population continues to expand, climate change is a very real issue and scarce resources such as oil, water and food will be in hot demand.
At any point in time, a number of ideas or themes will exist that look to dominate the investing landscape for the next several years or even decades.
Previous examples include the automotive sector in the 1920s, construction in the late 1940s, telecommunications in the 1970s, software in the 1990s and finance in the early years of the new millennium.
Quality global investing themes are ideas that are backed up by solid economic fundamentals such as population or demographic factors, shifts in consumer demand or looming supply constraints.
The five key themes we have currently identified are: Emerging market economies
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Water resources
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Commodities
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Clean energy
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Information technology
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Emerging markets
The term emerging markets is used to describe an economy where its social or business activity is in the process of rapid growth and industrialization e.g. China, India and Brazil.
Emerging market economies are projected to grow almost three times the rate of developed economies over the next five years. Their earnings are conservatively expected to grow twice as fast as those from the developed markets over the same period.
China stands out as the greatest opportunity within emerging markets. One reads stories in the press almost every day about China’s miraculous growth and its effects on the rest of the world.
Water
John F. Kennedy once said the person who solved the world’s water problems should receive two Nobel prizes, one for science and one for peace.
Access to clean water is under threat; for developed and emerging countries alike. Therefore investment opportunities exist in water utilities, water treatment and water services companies.
According to the OECD, water infrastructure in developed countries is ageing fast, and needs extensive and expensive rehabilitation.
For example, it is estimated the US will need an additional US$23 billion per annum for the next 20 years to keep the US water infrastructure functional and in compliance with regulations.
The UK and France need to increase the share of GDP applied to water spending by 20% just to maintain services, whereas Japan needs a 40% increase.
In emerging markets, population and economic growth will see water become a scarce commodity over the next decade. Growth in agriculture, energy production and industrial output all require ever-increasing inputs of water.
Commodities
A commodity is a good for which there is demand, but which is supplied without qualitative differentiation across a market. It is a product that is the same no matter who produces it, such as oil, copper, wood or milk.
When thinking about the outlook for commodities, the prospect for oil is a good place to start. Broader commodity prices often track oil prices because they share similar demand pressures with slow and costly supply responses.
Oil is also a large input into much commodity production so if energy prices rise they can drag up broader commodity prices.
With developing country and emerging market growth lifting oil demand and prices, it is proving harder to find and extract out of the ground.
This means we are likely to see a rising commodity price trend over the next decade, and as recent history has shown, the cycle around this trend can be extreme.
Clean energy
Clean energy can be generally defined as energy from renewable sources such as biomass, wind, or solar power and does not produce pollution.
It’s an investment opportunity to follow closely over the next few years due to the combination of structurally higher oil and gas prices, consumer concerns over global warming, and government incentives and penalties.
Information technology (IT)
The IT sector has the potential to do well over the short and longer term. In the short-term, a recent study by McKinsey shows that US$60 billion of the current US stimulus package will be targeted directly at high tech and telecommunications
Including indirect government technology outlays, it is estimated the level of expenditure rises to over US$200 billion.
The sector continues to be a leading source of innovation and value-add and governments are becoming increasingly active in fostering IT take-up to promote lasting economic growth and development.
Internet access is a key focus and in June 2008 the OECD countries stated their common desire to promote the internet economy. .
How do you plan to participate?
To allow easy investor access to these themes and others over time, Spicers has established the Focus Global Themes fund. This fund is managed for Spicers by AXA Global Investors. The fund aims to provide investors with a cost effective way to participate in some of the world’s more interesting and potential profitable investments.
Receive your FREE copy of Spicers booklet: Investing In Global Themes by clicking here to download
From Spicers Portfolio Management
Managing your money behaviour, and avoiding common behavioural traps, can help you put the right foot forward when it comes to long-term success with money.
Why do mature women make better investment decisions than young men? Why does trading shares online bring worse results than the old fashioned way? Why do we all think we’re better-than-average with money (and other areas of life)? And what can we do about it?
The emerging area of behavioural finance research – which looks at the way we behave with money and investments – is shedding light on questions like these. And the results are fascinating. How we think about and manage our money has a huge impact on our lives – especially in the current environment. The good news is there are effective strategies to help us keep perspective, whatever happens in markets.
If it looks too good to be true…
One of our better human traits is that we’re basically optimistic. But this also makes us vulnerable to 'too good to be true' marketing offers. As a society we spend twice as much on mass marketing than on education. So it’s little wonder we’re influenced so strongly by our environment and the promises of a consumer culture.
One of the few benefits of the global financial meltdown is that operators of dodgy investment schemes and 'too good to be true' offers have been put out to pasture. Sadly, there has been a human cost. Perhaps the most infamous scheme, run by Bernard Madoff in the United States, reportedly cost investors as much as $65 billion. For his trouble, Madoff received a 150 year jail sentence in June this year. 'If it looks too good to be true, then it probably is.'
The price is right
'Anchoring' is another simple way that we lose perspective. Any advertisement that follows the simple formula 'recommended retail price $50, now $30—save $20,' is trying to influence our judgment by using an initial anchor price of $50 to show what a good deal is now being offered.
The technique is also used by some real estate agents who, when observing a potential buyer’s interest in a property, will casually mention that the vendor is looking for a price a good 10–20 per cent above what the vendor will probably accept. Anchoring plays a big role in the stampede of every big market downturn.
The good news is there are effective strategies to help us keep perspective, whatever happens in markets.
To get ahead we need to deal with today’s reality, rather than anchor on the past. Remember the only investment value that truly matters is the one you achieve when you sell. So be aware of price anchors, by all means, but don’t base decisions on them.
We’re overconfident (and we don’t know it)
Anchoring is made worse by our habit of being over-confident in our abilities, particularly with money. So we need to know our own limitations. Psychologists believe that overconfidence is much more common than most of us care to admit. For example, most people rate themselves as 'above average' at everyday tasks like driving a car, when this is statistically impossible. Clearly, not everyone can be better than average.
Confidence is good but within limits. Overconfidence contributes to the tendency of many investors to:
- try to do it themselves, without the right skills and experience
- make decisions too rapidly, without sufficient analysis
- fail to diversify portfolios enough, hoping that one big bet will pay off
- buy and sell investments too frequently.
This helps explain why mature women are better with money than young men: young men suffer more from over-confidence than do mature women.
One of the leaders in behavioural finance, Terrance Odean of UCLA, analysed the trading activity of 10,000 accounts of stockbroking clients. He found that on average, the shares that investors bought did worse than those they sold. In other words, most investors would have been better off sticking with what they had than flipping between investments (which also racks up transactions costs). This is why, even during boom times, up to 70 per cent of market day-traders may actually be losing money.
Technologies like the internet make this worse. Not only can you think impulsively, you can now act impulsively, trading online instantly. Odean found that investors who moved to online share trading actually traded more, speculated more, and achieved lower returns than those who didn’t.
So while in bad market conditions, there may be a terrible pressure to 'just do something', buying and selling investments to scratch this itch probably won’t help - and may well hurt.
Golden principles
One way to combat these behavioural traits is simply to be aware of them. But unlike the exciting fly-by-night investment schemes we mentioned earlier, the main strategy to take control is seemingly ‘dull’. Set your money strategy based on what the world is like today, and adjust plans as circumstances change (which they will do constantly). No financial strategy can afford to be 'set and forget'.
Successful investment approaches through history have applied four Golden Principles:
A boring, conservative approach? Maybe. But one that provides a good chance of success in the long run?
We think so.
From Spicers Portfolio Management
Shakespeare may have said, “Neither a borrower nor a lender be” but at some stage most of us need to use debt for major purchases like a home. What we don’t need is someone else’s debt. Yet that’s just what older parents are agreeing to take on when they act as guarantor for their adult children’s home loans.
Earlier this year, a Commonwealth Bank survey in Australia found that around 87 percent of parents would like to help their children purchase a home. And lots are doing just that – and good on them.
High property prices have seen a significant increase in loans involving support from family members, with many agreeing to act as guarantor.
Acting as guarantor is considerably more than a mere formality. It means you become responsible for the loan, if your adult child can’t make the repayments.
In today’s environment of generous grants and historically low interest rates, which encourage home ownership, older parents need to be especially careful about going guarantor. It may only take a modest rise in rates for some first homebuyers to face difficulty managing their mortgage.
By the time our grown-up offspring are looking at buying their first home, parents are typically at an age where they should be focusing on building their nest egg. Having to pay their children’s mortgage could seriously derail the best laid retirement plans. At worst, it could mean losing the roof over your own head. That’s why it’s worth doing the sums with your kids to check that they can handle the loan, if – and when – rates start to climb.
Whatever you do, do not sign any document that makes you guarantor of your kids’ mortgage before getting legal advice. You need to know exactly where you stand and what your significant legal obligations are if you go guarantor.
There are other, less risky ways, parents can help out, like lending your kids part of the deposit, or offering your grown children rent-free living at home to really help them save. Having a bigger deposit would certainly take some of the sting out of rising loan repayments following from rising interest rates.
Saving for a first home is always a challenge, but it is achievable. A good financial adviser can help.
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