Broomer's Blog

Brexit Survey

Ahead of the outcome of the Brexit negotiations, Square Mile are reviewing UK equity options in our Managed Portfolio Service and considering funds sensitivity to the potential outcomes.

Accordingly, we surveyed the managers of the 48 UK equity funds with a Square Mile fund rating (an indication of the best fund managers in the sector) to investigate their opinions of how Brexit might impact the market and their portfolios. The questions and responses are as follows:

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Knowing What You Want

Einstein was once asked that if he had one hour to solve a problem that would save the world, how would he go about it? His advice was to spend 55 minutes defining the problem, to leave a comfortable 5 minutes to arrive at the solution.

This may sound a bit geeky but the more I think about this, the more I like it. For example, I recently was in discussion with a consultancy client who was in a quandary about which fund should be selected to replace an underperformer. The answer only become clear once we had clarified exactly what role the existing fund had within the wider portfolio.

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Hey Genius, You’re Worrying about the Wrong Deficit

The trade deficit dominates President Trump's attention and by some reports, he has been fixated on this subject since the late 80s when Japan seemingly threatened to take over the world. Clearly that episode did not end well for the Japanese economy, yet Trump has persisted in wailing about unfair trade practices with his main trading partners. To be fair, Trump's ultimate intention is to engineer freer trade is reasonable but is this really worth the risk of igniting a trade war to reset the balance?

Meanwhile there has been surprisingly little comment about the cost of his tax cuts. It may be more correct to consider these not as tax cuts but merely deferred taxation measures. Most of the personal cuts are earmarked to end by 2025 but even for the permanent corporate ones to be sustained, the money needs to come from somewhere. Otherwise it will necessitate cuts to expenditures. Trump reckons that the Laffer Curve will come to his rescue as the greater growth will lift tax revenues, but as this stage of the cycle this appears rather farfetched. Even using the fanciful assumptions in the White House projections, these tax cuts do not become self-funding over the next decade. While Trump believes that his policies will spur economic growth, there are good reasons to suspect that they won't.

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The more I scream, the faster they go

Investment is a difficult discipline but there lies some very simple tenets at its heart. One of these is that the more you pay for an investment, the lower the return. As we approach the final stages of this long bull market, profits are approaching a cyclical peak and investors are paying a hefty multiple for these earnings.

It is common in late stages of bull runs for 'market darlings' to emerge. These stocks seemingly are impervious to rain or shine and behave magically as both performance drivers and havens for investors during market corrections. That is, until one day, they don't, often sounding the death knell for the bull market.

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Outlook June 2018

Geopolitical events invariably cast a shadow over markets, but it is relatively rare for them to manifest into something that affects the economic cycle. Events that alter the secular trend are even more exceptional but this is not to say that they don't happen. Thatcher's deregulation drive of the 1980s and FDR's 'New Deal' are examples and we suspect that Trumponomics may be another. Labelling Trump's policies as Trumponomics is unhelpful since it hints of an underpinning philosophy, which is entirely absent. Political direction rests with a demagogue.

For decades, economies and markets have quietly benefited from freer movement of goods, capital and labour. This is a trend that has not only been halted but sent into reverse. The direct impact of $20bn of tariff costs on a $20tr economy will be trivial but adds unwelcome grit to the running of the system. It will be interesting to observe voters' reaction as the repercussions are felt. Already, mid-Western soybean growers are grumbling as soon might the blue collar shoppers of Walmart where 70-80% of goods are sourced from China.

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The Beauty Parade

Keynes famously used an allegory of a beauty contest to describe how markets behave in the short term. He posed the question of how you should go about betting on the outcome of a beauty contest. To be successful, you should not bet on who you think is the most beautiful contestant but those who you think the judges will consider to be the most beautiful. His point is subtle but distinct.

James Montier at GMO recently highlighted some apparent inconsistencies in the results of the Merrill Lynch Fund Manager Survey. He points out that a significant majority of fund managers now believe the US market to be overvalued,

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Trump’s Follies

It is galling to watch Trump's vain posturing as he parades around the world. It is easy to push his buttons; he seems to offer an entire keyboard of them. We may have sympathy with Gary Cohn's rumoured assessment of the man as being 'dumb as shit' but he is the one in power and we are obliged to objectively consider the consequences of his actions.

The tax cuts have been a good thing for the stockmarket, though these are now wholly reflected in prices. The improbable device of soaking the rich with even more wealth will almost certainly spur economic growth, perhaps by as much as 0.7% this year and a further 1.5% in the following one according to the Economist. However, this comes at a monstrous cost to the government deficit which will hit nearly 6% by 2020. Through modern history, the deficit has never been greater outside a time of crisis. This leaves the economy in a vulnerable position and the government's finances risk spiralling out of control if something untoward occurs.

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Outlook March 2018

A correction is normally defined as a fall of between 10% and 20%, January's downturn just qualifies with the S&P falling by 10.1%. The adage that markets head higher on the escalator and come down in the elevator could scarcely be more apt. Note that the S&P 500 is leading the global rebound from February's lows and already the tech sector is breaking new ground.

This stumble took us back only to where we were in the autumn and it has done little more than blow off the market froth that had developed over recent weeks. If global markets begin to run again (as we suspect they might) this episode will quickly be forgotten. The catalyst for the fall was the US Treasury market where yields had surged 45 bps over the first six weeks of the year. They have since stabilised. One board member of the Federal Reserve described this episode as "small potatoes". We absolutely concur and fear that it is only a taster of might be to come.

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So, how are we doing?

Our Managed Portfolio Service has just passed through its three-year anniversary. While we do not look to compete principally on performance, I was curious to see how our portfolios have done in relation to others.

In the below chart, we have added the fee adjusted performance and volatility characteristics of our longest standing volatility managed portfolio range. These portfolios (highlighted in orange) can be compared to funds in the IA Volatility Managed sector.

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Crypto-currencies

The link to this article contains one of the best descriptions I have read of how the crypto currency market is structured and how it may develop. For those interested in the subject, I strongly recommend it.

I have not met with the authors nor for that matter with anyone from the Australian based Platinum Asset Management. The firm does not have any funds readily available for sale in the UK. The Platinum website has developed enormously over the years and the insights section is well named. The firm's principal, Kerr Nelson, was recommended to me by an old colleague and I have kept an eye on his views ever since.

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