Before listing some of the risks we will face this year, let us define what we mean by «traditional investors». This term covers the vast majority of retail investors and even many institutional investors. These are the investors who put their money into traditional fixed-income and equity products typically marketed by banks. In other words, bonds and listed shares, as well as investment funds of all kinds that invest in these same assets, paying hefty commissions to the distributors (banks) to place them with their clients. Assets that performed well years ago, when the financial system was not overwhelmed by debt and the actions of central banks.
We must not lose sight of the fact that the conditions are ripe for most investors to have a disastrous year: The US stock market is by no means cheap; the European stock market is overshadowed by dark clouds of debt that threaten the very existence of the Eurozone as we know it; emerging markets with widely divergent economic outlooks; and global fixed income at prohibitive prices due to the distortion caused by central banks, which have been meddling left, right and centre for over five years now. Let’s look at these and other dangers in more detail.
One of the risks facing traditional investors in 2015 (and 2016…) is a potential slowdown or even a fall in the US stock market, since QE has now run its course and that market is now at the mercy of its own potential for corporate profit growth based on economic growth. Without any ‘doping’ or ‘steroids’ to keep propelling it to infinity and beyond. It is true that it may continue to rise for a while longer, but without fundamental justification. And every good investor knows that buying companies without attractive fundamentals—that is, when they are not cheap and with the intention of selling them when they are very expensive—is reckless, to say the least.
As for European equities, the truth is that they are not expensive. However, the internal uncertainties arising from the – perhaps permanent – insolvency of southern Europe, and the populist governments that are promoting institutional defiance towards the Troika and its austerity policies make the Eurozone a formidable hornet’s nest for any investor over the next 24 months. Not to mention the resurgence of the far right and its ultra-nationalist and anti-immigration ideology, a full-blown regression that is the polar opposite of what was the very essence of the European project. No one knows today where the Eurozone is heading, but what is certain is that in five years’ time it will be very different from what it is today, as it is no longer sustainable to conceal Greece’s insolvency any longer, and who knows how many more peripheral countries might be dragged down with it.
If we look at traditional fixed income—that is, listed sovereign and corporate bonds, with their ratings having been compromised yet still holding sway—the outlook is even more bleak. To the excessive debt levels of issuers in the developed world must be added the exorbitant prices at which these bonds are currently trading. Central banks have ensured that insolvent debt issues trade at very low yields, that is to say at very high prices (Spanish, Portuguese, Greek, French, Italian, Japanese and US bonds, etc.). And the logical consequence of this is that solvent bonds trade at yields of practically zero or negative. A Machiavellian and perfect incentive for money to flow into buying debt of dubious solvency in search of some return. After all, someone has to keep the system afloat, and who better to do so than a few institutional investors alongside the vast majority of retail investors and savers. This is how, in recent years, a vicious circle has been created and the debt ball has kept rolling. The lower the yield on solvent debt, the more money flows into insolvent debt in search of a return, thereby keeping its price high and its yield low. It doesn’t matter that the creditworthiness is more than dubious; what matters is that the music keeps playing and that the banks keep putting their clients« money into expensive, insolvent debt in exchange for a few measly basis points of return. The general consensus seems to be: »After all, as there’s no inflation, an annual 3% is good enough’. And, incidentally, it is overlooked that this 3% is being offered by a worthless piece of paper from a heavily indebted issuer with a maturity of many years, which will go bust as soon as the wheel starts to slow down.
This is how we’ve been operating over the last three, four or five years, but perhaps 2015 will be the turning point. A pause along the way that could be marked, for example, by Greece’s default (or debt restructuring, to use politically correct language) in the first half of the year, or by an interest rate rise in the US in the second half. Both events could undoubtedly destabilise the fragile balance that has so far allowed traditional investors to avoid losing money (or even make a profit) in equities and fixed income. But the major destabilising factor looming over the entire planet is undoubtedly the collapse in oil prices. A fall in prices that Saudi Arabia (and who knows, perhaps the Islamic State itself and/or the US) is using as a weapon to alter the established world order (sic). In short, there is no shortage of reasons why the bubble of virtual solvency and the artificial propping up of developed stock markets will come to an end in the coming quarters or six-month periods.
The issue that should concern every investor is finding an alternative to traditional investment, which faces such a bleak outlook. Finding an asset that allows them to make a steady profit in the face of such imminent volatility and uncertainty. It must be said that there is value to be found in certain emerging stock markets, of course. However, it is risky to invest in the typical emerging market funds that large asset managers market through banks, as they mix very diverse countries and economies, which may react in very different ways to the events we are currently experiencing and will face in the near future. It is therefore better to invest through local boutique fund managers in the countries with the greatest stability and value in their companies and economies. These managers know their country very well because they are based there, experiencing the day-to-day reality of those economies and their governmental and economic policies and outlooks. If we believe, for example, that Thailand has good prospects, we should invest in the best local Thai fund manager, that is, the Thai Bestinver (well, what Bestinver was before its star managers left). The same applies to China, Hong Kong, Korea, Chile or Russia (if oil prices allow). Always looking for the best local fund manager with a value philosophy. But of course, most of these funds are not included in the sales catalogue of international banks, and bankers will try to place their own funds – or the funds of management firms with which they have marketing agreements, i.e. commission-based deals – emerging with mixes managed at a certain physical or psychological distance. It must also be said that despite being able to invest in these brilliant local boutique managers, volatility will be present, as turbulence in Europe, the US and/or oil prices will have a global impact. But as you should already know, volatility does not in any way mean risk. The risk lies in buying companies that are expensive relative to their current and future earnings; that is what generates definitive losses.
For the portion of portfolios that cannot withstand stock market volatility, the solution lies in lending or investing our money in exchange for its return with interest or profits, just as with traditional fixed-income investments. But doing so in assets that are far removed from the insolvency and valuation volatility of listed bonds. As we discussed in «Generating income in a scenario of expensive bonds and rising rates«Among the various strategies we are currently implementing are: Bridge loans to US, Canadian or Australian companies for 60 or 90 days, investment in mortgage markets with rising property prices such as in the US, arbitrage in international commodities trading, purchase of life insurance, etc… All of these are carried out through investment funds that ensure proper diversification; these are strategies that are not directly affected by the price of crude oil, rising interest rates, an increase in insolvencies, falling bond prices, etc. In other words, a source of income which, given the global scenario we face in 2015, is and will be like pure gold for the traditional investor. It is a pity that most will continue to be invested in debt that is potentially insolvent and more volatile than they could ever have imagined.