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Diary of a fund manager - Multi-Story - 14.05.18

David Miller, Investment Director, Quilter Cheviot

This week’s Diary focusses on the risks of complacency, where next for interest rates, the Second Law of Thermodynamics and what Picasso had to say about inspiration.

Investors had a good week with equities delivering good returns. Oil also moved higher, but this was more to do with Iran than business. Anything tainted with safe haven status such as gold, government bonds, and even the US dollar drifted lower, although with little conviction. The pessimists are being squeezed by unforgiving optimists just at the moment.

In a world of low interest rates, every investment that could make a return involves risk. This has been the case for approaching 10 years and so is hardly new news. The US economy has now been growing for 107 months which is the second longest upswing in history. Only the 1990s record remains to be beaten. Staying in the US, the quarterly results season is coming to an end with average earnings up by nearly 25% which, as someone wanting to make a point observed, is 10 times higher than average wage growth. Despite higher fuel prices, inflation indices are below expectations and central banks are resorting to words rather than actions. The Fed is still likely to raise interest rates three more times this year, but whether this will continue next year will depend on the numbers. In the UK, the Monetary Policy Committee voted 7-2 at its May meeting to keep rates unchanged. A split decision might be taken as a signal that we should prepare for higher rates later in the year, but not according to the “view of the market”.

Does all of this add up to buy in May and go away? Well, of course not, even setting aside the knock on effects of the US decision to withdraw from the Iran nuclear deal. Money has been mispriced for a decade and, because this has been going on for such a long time, all parts of the global financial system have been affected. That’s why the prognostications of those who control interest rates matter so much.  If rates were ever “normalised,” which is code for back to where they were before the credit crunch, then that would now be abnormal. Cheap and readily available money has flattened risk to the extent that the volatility spike in early February which unsettled markets has already become a distant memory. In the natural world, entropy increases with time as the difference between energy levels decreases. When everything is the same temperature then nothing more can happen. Investment markets do not follow the Second Law of Thermodynamics, but the concept has its uses when looking for return in an ocean of complacency.

Reflecting on these matters with two highly experienced investors on separate occasions last week, unexpected insights emerged which, although unconnected, coalesced into a challenge to the view that nothing short of ‘war war’ rather than ‘jaw jaw’ will disturb markets. Unlike economies which are driven by higher earnings, equity markets are driven by earnings per share. For example, the announcement by Apple of a $100 billion share buyback pushed the share price up 4% on the day and contributed to a 10% increase since the announcement of excellent results. Those who manage companies and those who own shares are rewarded when earnings per share are on a rising trend. Cheap and available credit means that both good and bad companies can follow the same strategy, and superficially the bad, or should I say less successful, look just as good as the winners. Balance sheets are an important measure of a company’s strength, but can be built on sand. In good times concepts like brand value and goodwill are accepted as assets, but when times are hard these accounting conventions are very difficult to turn into cash flow. Easy money, imaginative balance sheets, and excessive buy backs can turn toxic. Japan, which went through a long period of cheap money ending in 1989, has taken a long time to come out the other side. These days, however, it has more companies with “fortress balance sheets” than in other parts of the world. Understanding risk never goes out of fashion, but is particularly important after a long period of expansion.

Picasso has been in the news following the sale of one of his early paintings for $115 million. As he put brush to canvas at the age of 24, I wonder if he knew that his genius would ever be so highly valued? Then, during a concert and gentle fundraiser performed by a few members of the Multi-Story Orchestra, which I had last seen in action playing Beethoven’s 7th in the Peckham multi-storey carpark a few years ago, a partial answer emerged. The composer of one of the pieces was asked about how she goes about being creative to order. “Well, what I do is sit down every day and try” came the response “and above my desk is a quote from Picasso who said that inspiration does exist, but it has to find me working”.

And finally, I now have a blog.

Ask David a question

Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.


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