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Quotidian Investments Monthly Commentary – June 2016

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July 6, 2016

We ended last month’s report by highlighting that the two most obvious stock-market sensitive issues in June would be the Federal Reserve decision on US interest rates at its mid-month meeting and the outcome of the UK referendum on EU membership. Of course, we now know the actuality in both cases.

Predictably and as entirely expected the Federal Reserve decided to leave US interest rates unchanged at their mid-month meeting.  At the press conference following that meeting Janet Yellen used 13 variations of the word “uncertainty” in her summary of the Fed’s views.  Hardly confidence inspiring stuff.  We remain of the view that US interest rates will stay on hold until December at the earliest.

Elsewhere, interest rates are now at zero or in negative territory.  For example:

  • The interest rate in Switzerland is at minus 0.75%
  • In Sweden at minus 0.50%
  • In the Eurozone at minus 0.40%
  • In Japan at minus 0.10%
  • In Great Britain at +0.50%
  • In conjunction with this, global bond markets also continue to go from bad to worse.

Switzerland’s central bank announced that it will be selling a 13-year bond with a yield of zero. If you now want to earn a positive yield on Swiss debt you have to go out to a term of 20 years.

The finance arm of Toyota Motors has just offered a three-year unsecured loan note with a yield of 0.001%.  To put that into better context, if that was your yield on a savings account it would take 69,300 years to double your initial investment.

Germany’s Bundesbank has just published a measure of the average yield on that country’s government debt which showed that the average had just dropped below 0% for the first time ever.

In fact, early in June the yield specifically on the benchmark German 10 year bond sank to within two basis points (two-hundredths of one percentage point) of zero.  Then, on 14thJune and for the first time in its history, the yield on that 10-year bond went below 0% and later fell as low as minus 0.035%.

Early June the yield on the Japanese 10 year note fell to a record-low negative of minus 0.15%.

This has coincided with a massive worldwide push toward lower and lower yields with Japanese 10 year bond now declining even further to minus 0.19%, Swiss 10’s falling to minus 0.55% and British 10’s dropping to an all-time low of 1.11%.

Meanwhile average incomes have been stagnant for nearly a decade.  Given this scenario and the alternatives on offer, for an investor who wishes to make a positive return and hope to keep pace with inflation it does rather make an unequivocal case for equities as being the only potentially beneficial and liquid asset class in today’s investment environment.

The relentless doomsday narrative of David Cameron, the Bank of England and their erstwhile fellow-travelers around the world had the effect of setting the scene for a self-fulfilling financial panic following the UK referendum result in favour of leaving the EU.

Their claims were based on dubious analysis and were deeply irresponsible. Markets panicked entirely as a result of the hysteria that this scaremongering had quite deliberately generated.  Policymakers around the world were then duty-bound to dampen financial turbulence and, indeed, within a week the main UK index has regained its pre-referendum levels.  It may take slightly longer for the mid-cap and small-cap sectors to make a similar recovery but, essentially, the current downturn in valuations will be transitory.

A study from the International Monetary Fund (IMF Country Report No.16/169 dated 1stJune) which, quaintly, was released at the same time that Madame Lagarde (the IMF Chief Executive) was issuing her dire warnings about the extreme dangers of Brexit, clearly shows that the share of British goods exported to the European Union had fallen to 45 percent in 2014 from the 60 percent it had been in the year 2000.  More recently it has fallen even further to 42%. This ongoing shift away from slow-growing Europe and towards the rest of the world was always set to continue irrespective of Brexit.

Modern economics is based on calculus; the field of mathematics developed by Isaac Newton (and some say Gottfried Wilhelm Leibniz) in the 17th century.

It is still that branch of maths which underpins many economic forecasting models.  Indeed, the same model that earned Professor Lawrence Klein the 1980 Nobel Prize in Economics is essentially the one that Federal Reserve still uses today and it is also the forecasting approach relied upon by many establishment economists all over the world.

And it’s all still based on 17th century calculus, which is very good at calculating rates of change but very inadequate for predicting changes in direction; and it is absolutely dreadful when it comes to anticipating sudden breaks with the past. That’s why most economists in the public sector are as clueless today as they were in failing to foresee the financial crisis of 2007 onwards and predict the detrimental effects of the Euro on the economies of so many countries in the Eurozone.  The woefully inaccurate forecasts produced in the lead-up to the UK referendum provide further evidence of the dangers of complacent, unquestioning group-think.

The entire official campaign in favour of remaining in the EU was based on claims that British productivity would fall precipitously. There is absolutely no evidence to support this assertion.  At the very least, the long-term economic consequences of Britain leaving the EU are neutral to positive.

Upon leaving the European Union Britain will possibly trade even less with Europe but much more with other nations around the world.  The current decline in value of the British pound against the US dollar will, of course, be of great benefit to the competitiveness of British goods in export markets but, whilst it is entirely possible that overall trade may fall somewhat during this potential transition, there is a consensus among business-focused economists that the costs of such a decline would be small and short-lived. 

On 30th June the FTSE 100 closed at 6504.33(a rise of+4.19%for the 2016 year to date). By comparison the Quotidian Fund’s valuation at the same date shows a fall for the month of June of –12.89%(all of which came as a result of the post-Brexit panic) and for the year to date is now – 21.37%.

As you already know, in the two days following the Brexit vote the wheels came off the UK stock market.  The FTSE100 fell by roughly 8% and the wider market by much more.  The FTSE 250 was marked down by over 14% in just those two days.

Contagion spread to global markets far and wide.  The Dow Jones Industrial Average plunged 871 points in those same two days, whilst the S&P 500 sank to a three-and-a-half-month low.  The Nasdaq Composite also tumbled more than 315 points post-Brexit and there was absolute carnage in certain sectors of the markets.

Pharmaceuticals have always been widely seen as a defensive sector but, perversely, it was one of the worst hit in this short-term valuation mark-down. However, there is already growing confidence in the City that this initial pessimism was overdone and that the implications of Brexit may not be as far-reaching as the doom-mongers had suggested.  I have no doubt that share prices will continue to be marked up again to pre-referendum levels in the oversold sectors of the market.

In the short term we find ourselves back at our end-of-February levels of valuation.  I can do no better than repeat the essence of what I said at that time:

Market turmoil following the UK vote to leave the European Union is well beyond irrational and better described as insane, but it istransient.  Share prices have always recovered after mark-downs in the past and they will recover this time too; it is only a function of time before our holdings return to more realistic valuations.

We remain entirely comfortable with our current portfolio holdings; we have held firm and haven’t been panicked into selling any assets as this downturn has persisted. We haven’t, therefore, crystallised a paper markdown into an actual loss.

Immediately before the referendum took place we were very near to positive territory for the year to date.  By mid-June we had recovered almost completely from the early year pricing mark-downs and I have no doubt that we will soon recover the ground lost in this post-Brexit panic too.

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