Is there any good news from the markets?

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The good news just isn't getting through

Hope is not a strategy...so how can you manage financial risk effectively?

A European "fiscal compact"

By Murray Harris, National Investment Manager, Spicers

As the old saying goes, “bad news sells newspapers.” That certainly seems to be the case for any news item concerning the world’s financial markets and the global economy over the past few months. The source for most people’s daily diet of news and current affairs continues to be radio, the 6pm television news or the newspaper. And of course, increasingly we are using online media and the internet. No matter the source, recently the headlines have been the same: “Dow Jones down 200 points!”; “Markets plummet yet again”; “Turmoil on the global markets”…the list goes on.

Yes the Euro-zone crisis is big news. In fact, it is history in the making. We are witnessing some defining moments as politicians and governments pay the ultimate price for decades of excessive spending and lax management of ‘the books’. This is important news and does warrant the media’s attention. But, like everything, there are two sides to every story. The world is not ending, and there is plenty of good news out there – it is just not making the headlines.

Whilst we cannot ignore the Euro-zone crisis and its impact on financial markets and potential impact on the global economy, we do need some balance in the news. What about the good news which is happening across markets and economies which are signs that outside of Europe, things are pretty good?

What’s the news from the US?

Let’s take the world’s largest economy – the United States. Things there are pretty good considering, with economic growth (real GDP) for the year to the end of September 2011 a respectable 2%¹ . Ok, that’s not as strong as we might expect coming out of a recession, but in an environment where the consumer is continuing to pay off their debt (and that’s a good thing) rather than spend freely as they have when coming out of previous recessions, then that is a credible result. We have also seen a slow but steady improvement in US employment over the past few months with net jobs growth, primarily driven by the private sector. That means factories and stores and restaurants are employing people again. That’s good news! The unemployment rate has fallen from over 10% six months ago to a two and a half year low of 8.6%²  in November, and whilst that figure may tick up a little in coming months due to seasonal affects, the trend is moving in the right direction - downwards.

Corporate America is also in good health; however we don’t see too many headlines about that. Third quarter earnings season for US companies in the S&P500 has recently concluded. 70% of those companies reported earnings above the market’s and analyst’s expectations³. This is a trend which has been continuing now for 10 quarters in a row. From their Q1 2009 low where earnings fell to near Great Depression levels, falling 92% from their Q3 2007 highs, earnings of S&P500 companies have bounced back – up over 1100% to the end of Q3 2011⁴. Yes, we know a worsening of the Euro-zone crisis will have flow on affects for the US economy and for US companies. But, both of these are in much better shape now than they were before the GFC and therefore are likely to weather the storm far better. Barring a catastrophic failure of Europe, we are not expecting another recession in the USA.

And then there are the emerging economies of the world. These economies have become far more important and influential in the global economy over the past decade, and are one of the reasons why a recession in Europe may have less of an impact on the developed world than in the past.

How is the economy fairing in China and India? 

Economic growth in economies such as China and India has been racing along, whilst the developed world has been pulling itself out of recession. GDP growth in China for the year to September 30 2011 was 9.1% and has been running at around 10% pa for the past two years⁵. In India it has been a similar story, with GDP growth running at between 7% and 9% pa for the past couple of years. In total, the emerging economies of the world have been growing at around two and a half times the pace of the developed world. Emerging markets continue to be the ‘fuel in the engine’ of global economic recovery.

Whilst inflation has been a concern in China and India of late, it would appear the central banks have effectively managed this downwards, which is good news. This will slow economic growth in these economies a bit, as will the flow on effects of the European crisis, however growth will still strongly outpace the developed world.

So what is an investor to do?

Now more than ever the world is interconnected and events in one market or economy can affect others rapidly. As investors, we have a diverse range of assets and markets in which to invest. Diversification is of course the key to a successful investment strategy – not having all of your eggs in one basket.

It has been a challenging – and in some regards a worrying year for investors as they have ridden the rollercoaster of global financial markets. But for those with a good spread across growth, income and alternative assets the ride has been less hair-raising. To the end of November the return⁶ for the past year from a basket of world shares is -4.67%; Australian shares -4.08% and NZ shares a credible +1.70%. These returns reflect the concerns of investors globally and their lower appetite for higher risk growth assets.

Compare that to returns from lower risk income assets such as NZ property +12.13%; NZ government bonds of +11.82%; world bonds +6.11%; global property +3.42%; and alternative assets such as global infrastructure +3.43% and commodities of +2.5% and the benefits of diversification are immediately apparent.

How many news headlines have you seen recently telling the good news of returns from more defensive assets? Perhaps as we turn our minds to the festive season and enjoy a well-earned break with family and friends we should turn off the TV, put down the newspaper and tune the radio into the cricket. That might be better for investor’s nerves - because the good news just isn’t getting reported. 

By Spicers Portfolio Management Limited

Life involves risk.

Every time we buckle-in for a drive in our car, we face at least a faint possibility of something unexpected happening that could prevent us from reaching our intended destination. Putting on a seatbelt, following the road rules and controlling our driving speed are some of the many tools at our disposal to control the risks we face when we are behind the wheel.

The same is true for financial planning. Creating a successful financial plan requires more than just identifying someone’s goals and objectives and putting an investment plan in place to achieve those aims. That is important; but equally important is identifying and managing any risks that may prevent someone’s financial plan from arriving at its chosen destination.

Some of the common financial risks facing retirees include:

• A loss of investment capital, as it cannot be replaced by future salaried earnings
• Longevity risk (i.e. the risk of outliving your money)
• The prospect of health insurance eventually becoming unaffordable

For pre-retired people with dependent children, one common risk is the impact that an unforeseen loss of income would have on a family’s quality of life.

Each of these risks has the potential to interfere with the success of a financial plan so, wherever possible, it is important that an appropriate risk management strategy is put in place to mitigate that risk. Risk management doesn’t necessarily mean buying an insurance policy, although this is often one of the options you can consider.

In general, risks can be controlled, retained or transferred. Choosing to ignore significant risks, or hoping that an identified risk doesn’t eventuate, is usually not recommended. You only have to look at the plight of uninsured homeowners in the wake of the Christchurch earthquakes to be left in no doubt that “hope” is not an effective strategy.

So, let’s look again at the common risks we have identified above:

Controlled

In the case of the retirees who are unable to absorb periodic capital losses caused by fluctuating investment markets, a common solution will be to carefully control the level of investment risk taken.

Longevity risk can also be effectively controlled by assessing the amount of income that can reasonably be generated by the available investment assets and establishing a sensible budget to live within this amount.

Retained

If health insurance eventually becomes too expensive and has to be given up, then an alternative approach might be to direct as much of the “saved” premium cost as possible into a designated bank account. Over time, the build-up of funds in this account can be directed solely to the payment of future health expenses. This approach would be considered an example of a risk that is retained by the individual, with the full costs to be met by them.

Transferred

In the case of the pre-retired couple, the unexpected loss of income of the principal bread-winner might arise from the permanent loss of a high-paying job due to a major health event, or perhaps an untimely loss of life. In these cases the identified risks can often be successfully transferred to an insurance company offering major trauma and/or income replacement insurance, or life cover.

To summarise, the most important thing from a risk management perspective, is that once you have identified and quantified a potential risk factor, you will generally have at least one option at your disposal to help mitigate the impact of this unwanted event occurring. By implementing strategies to control, retain or transfer the different risks you have identified, you will ultimately be giving yourself the best possible chance of arriving intact at your chosen financial destination.

By Bevan Graham, Chief Economist, AMP Capital

Important progress was made at the latest European Summit. As was signalled pre-Summit by the French and German leaders, the important outcome was a “fiscal compact” amongst the members of the Euro Zone. The show of political unity at the Europe-wide level is a welcome development, although the UK has already opted out (this is likely to cause tension in the UK coalition government).

The agreement will require each member to introduce new rules on public finances into their constitutions which will have to be ratified by individual parliaments. There will be penalties for countries that then break these rules. However, political risks remain high as domestic politics in some countries may still get in the way of a fully-implemented outcome.

Other outcomes from the Summit include European central banks providing the IMF with €200 billion to use in Europe with the expectation (hope?) that other countries will contribute. The start date for the European Stability Mechanism (ESM), the permanent mechanism that will eventually replace the EFSF, has been brought forward to July next year. This will provide a further €500 billion of capital. Finally, demands that investors share in the costs of future bailouts have been dropped. This will go some way towards restoring investor confidence in European sovereign bonds.

The “fiscal compact” provides for a stronger fiscal framework in Europe. It should have been part of the original setup of the common currency, but that’s history. Alongside further measures from the ECB last week to provide liquidity to the European banking system, some progress has been made.

However the increase in the bailout funds will most likely be insufficient to relieve stress in sovereign debt markets. For that we are still looking for a stronger commitment from the ECB to step-up its purchases of bonds. Without that, the pathway to lower bond yields in Italy and Spain will be ever more austere budget initiatives. That will be counter-productive in terms of ensuring an appropriate balance between fiscal consolidation and supporting economic growth.

As we have warned after each of the previous “solutions” to the European debt crisis, there is still a lot of water to flow under the bridge. The critical factor in the period ahead is how the ECB see’s its role in alleviating pressures in sovereign debt markets. Watch this space.

Your feedback is welcome

Financial Update is a regular publication published by Spicers Portfolio Management Limited. It discusses topical investment and financial planning issues. A disclosure statement is available on request, and free of charge from you adviser.

The Spicers approach is to meet with a potential investor and ascertain what their individual needs are before making any recommendations. We believe that quality advice incorporating a robust planning process should be the foundation of any investment service provided.

The planning process starts with discussing what is important to clients. This may include achieving financial independence, repaying the mortgage, educating children, supporting ageing parents – all while enjoying a good lifestyle. We then review the overall financial position now and how it might unfold in the years ahead.

Once we know what is important and how the financial position looks, we can then work with our clients to tailor a financial plan to help make it happen. Importantly, once we understand what is important to our client, we can then provide a specific recommendation on the type of investment portfolio to support the plan.

Please provide feedback directly to your adviser or email spicers@spicers.co.nz

Disclaimer

The information in this publication is of a general nature only and is no substitute for personalised advice. If you would like advice that takes into account your particular financial situation or goals, please contact your financial adviser.

The information has been published in good faith and has been obtained from sources believed to be reliable and accurate at the time of publication (19 December 2011). The opinions contained in this document reflect a judgment at the date of publication by Spicers Portfolio Management and are subject to change without notice.  Past performance is not indicative of future performance and is not guaranteed by any party.