Comment: A time for analysis, not panic
‘Don’t panic! DON’T PANIC!’ (starts to walk up and down excitedly)
~ Lance-Corporal Jack Jones (played by Clive Dunn), Dad’s Army, BBC Television 1968-1977
Last week, a major UK bank told its clients to sell everything except high-quality bonds, to avoid the effects of a looming global deflationary crisis. But is that really good advice?
RBS made the announcement while advising clients to be prepared for a “cataclysmic year” for markets, as CNN reported. Andrew Roberts, the analyst responsible for the announcement, told investors in a note that he’d already seen the bank’s red flags in the first week of 2016. He compared the mood in the markets with that of 2008 before the collapse of Lehman Brothers, and the beginning of the global financial crisis (GFC), explaining that the bank thinks investors should be afraid.
I’m not so sure.
Usually in January I make forecasts for the year ahead. But 2016 looks more unpredictable than any year I can remember. There are very good reasons to believe that the global outlook may look gloomy at best for the medium-term, but it’s quite another thing to forecast any decisive trend specifically within the next 12 months.
For that reason, for the first time in my career, I’ve decided to hold back from forecasts, on the grounds that in such an environment, quite frankly anything could happen. And instead, I’m just going to try to explain how to be ready for the best and worst case scenario, and every possibility in between. Which, as it happens, does not necessarily mean selling everything off in a wild panic.
Right sentiment but wrong statement
The RBS statement certainly made the headlines. But that kind of announcement concerns me because, if replicated by other large banks around the world, it could cause widespread panic, and thus hit prices in all kinds of markets – almost a self-fulfilling prophecy.
It’s fair to say that the reasoning behind the bank’s announcement may be sound. Central bankers have been talking up economic performance up in recent weeks, such as Fed Chair Janet Yellen’s claim of “considerable progress” in the US, as she raised interest rates by a measly 0.25% (if things are that good, why not go higher, Janet?). Yet it doesn’t feel like the world is recovering from the GFC.
In fact, I’ve been explaining for some time that the global economy appears to be heading for another crisis, one that could be potentially greater than the GFC, because the real problem wasn’t identified in the first place. Many of the elements are there: plummeting oil prices, coupled with falls in the commodities markets generally; extremely low inflation in the Eurozone and the US; and continuing high levels of private debt. And this time, China is in no position to soften the blows, as it did seven years ago.
It’s believed that the People’s Bank of China spent US$500bn to support the Yuan in 2015. RBS analysts reckon that the currency would need a devaluation of as much as around 20% to be reached before capital outflows from China start to ease, so that it could support the global economy.
Central bankers haven’t thoroughly understood that private debt caused the problem, and that they have relied too heavily on China.
If we add in to the cocktail such non-economic factors as war, global terrorism and environmental issues, it is clear that the world is facing some huge socio-economic challenges.
So what should the individual investor do? One thing that’s clear is that no one should panic.
After all, it’s not as if this scenario has crept upon us. Instead, we should expect markets – and consequently portfolios – to be vulnerable to severe corrections.
How much you’re affected by dropping values, of course, depends on the nature of your investments. If you’re very exposed to risk assets, such as commodities, stocks or property, you could be in for a very nasty shock. I frequently analyse portfolios that are widely touted as being suitable for ‘typical investors’ (whatever that actually means), that our proprietary risk models indicate could fall by 60% or more. Needless to say, this realisation comes as a huge surprise to investors, but at least we’re able to give a ‘heads up’ on this, rather than investors finding out the painful way.
If, however, you’ve followed the kind of advice that we’ve tended to give over the years, and opted for a balanced asset allocation designed in a way bespoke to your own risk profile, time horizon and liquidity and currency requirements, then you’re likely to be much better positioned for the current turbulence.
I’m in no way suggesting investors simply close their eyes and hope for the best, nor am I saying that everything will turn out OK in capital markets in the long run (because that can sometimes be a very long run, longer than the life expectancy or patience of investors).
It’s important to be sure your assets are allocated, as much as possible, to meet a target risk-level with which you’re comfortable.
As I have often remarked, investors can control how much risk is in their portfolios – that is an input. They can only influence the returns that they get as an output from their investments.
However that doesn’t allow room for complacency – markets are movable targets, and risk allocation should be analysed regularly by an independent expert. Risk of loss and correlations are not constant.
The point is to ensure decisions are taken objectively, without loyalty to a particular asset that, for example, may have done well in the past, but looks like flagging in the future.
To give you a theoretical example: if someone has a retirement or education fee plan due to mature in 15 years’ time, and its value has dipped by, say, 10% in the last six months or so, that is not necessarily cause for alarm, and doesn’t mean that they should press the panic button and decide to get out immediately.
That person should, however, be aware of his/her portfolio. They should ask whether they expected that kind of performance in these kinds of markets, and how vagaries of the uncertain future that we all face might continue to impact the range of possible returns that they face.
The key, even in today’s unpredictable times, remains that each investor still has the ability to control their investment risk.
Allow some tolerance
With that in mind, my recent advice has been to plan investment to allow for the possibility that we might see far greater price falls along the way, while having solutions ready to allow for any possible scenario. Allowing for any possibility means a greater reliance on risk management, and that may imply a need to lower return expectations.
Right now I feel that’s the way forward, at least until we have a major event, or a clearer picture that suggests a change in strategy. Sadly, the one prediction that I will make is that too many professional and non-professional investors will get caught out by being unprepared for the challenges ahead.
In any environment in which almost anything can happen, the key is to take the necessary right steps to make sure that you’re not caught unawares.
Paul Gambles is co-founder and managing partner of the MBMG Group, a Bangkok, Thailand based wealth management firm, since it was founded in 1995, and director of MGMG Investment Advisory. Licensed by the Thai Securities and Exchange Commission of Thailand, both as a Securities Fundamental Investment Analyst and an Investment Planner, he is a frequent expert commentator on numerous business news shows, including CNBC, the Money Channel, National Public Radio, Bloomberg TV, CNN, Thai PBS and CCTV.