Monthly Archives

June 2024

Jun 27
0

The investment case for China

By | Investments

After a decade of rapid growth, China has offered scant reward for investors since 2021. Where developed western markets have enjoyed strong returns since November, Chinese Equities continue to forge a contrarian path lower, despite a growing number of reasons why China appears to offer good value to investors. The graph below demonstrates the very different performance of the CSI China 300 index (shown in blue) compared to the S&P500 index of leading US companies (shown in red), priced in Sterling, over the last 3 years.

We take a look at some of the factors that have led to the underperformance, and outline reasons why we feel an allocation to China deserves a place in a diversified portfolio.

Continued growth

The Chinese economy has traditionally expanded at a rapid pace, with annualised growth of between 6% and 10% per annum achieved between 2010 and 20191; however, the rate of growth on an annualised basis has slowed over recent years. Covid-19 caused Gross Domestic Product (GDP) growth to dip, as was the case across the World, although the Chinese economy rebounded last year, growing by 5.24%. This rate of growth compares favourably to the US, which itself expanded by an impressive 3.1%, and very appealing when you consider the meagre growth achieved by the UK and Eurozone last year. Although the rate of growth predicted for the Chinese economy over the next five years is lower than pre-Covid levels, economists predict an annualised growth rate of around 4% per annum, which may well look attractive when compared to other leading economies.

Consumer recovery overdue

The Covid-19 pandemic was particularly damaging to the Chinese economy. Harsh lockdown rules capped economic activity to a large extent, and when the restrictions were eased in November 2022, economists expected a rapid acceleration and recovery, as domestic consumption rebounded and consumers spent money saved during the pandemic.

The reality has been very different to expectations, as consumer confidence remained stubbornly weak post-pandemic.  Very recent data has, however, indicated a slight improvement, with retail sales for May growing by 3.7% year on year2, reversing the downward trend seen over recent months.

The need to reflate

Most western economies struggled to contain spiralling inflation during 2022 and 2023, caused by increased demand for goods and services post pandemic, and the impact of war between Russia and Ukraine, which pushed commodity prices higher. Given the sluggish recovery in consumer confidence seen in China, inflation was barely positive for 2023, and the International Monetary Fund (IMF) predict Chinese inflation will only reach 1% this year.

Beijing has already taken measures in an attempt to stimulate demand, such as offering trade-in subsidies against the purchase of new cars and white goods, and cutting base interest rates late in 2023. It is likely, however, that further monetary stimulus will be needed, which could prove a fillip for investors.

Unemployment levels amongst young people also remains a concern, with 14.2% of those aged 16 to 24, who are not in full time education, looking for work2. That being said, this has steadily fallen from the 20% level seen last year, and we expect to see further measures to boost productivity and employment prospects, in particular in areas such as technology.

Property Market woes

One key reason behind the underperformance of Chinese Equities since 2021 has been the continued struggles seen in the real estate sector. Land and Property development, which according to analysts accounted for almost one third of China’s GDP at one point, boomed during the last decade, with much of the growth fuelled by debt. Overdevelopment saw a glut of unsold properties, spawning ghost cities amidst a buyers strike. Lack of consumer confidence in the wake of the pandemic, and demographic shifts are often cited as the key reasons for the extended slump in real estate prices.

As demand eased, and debts mounted, pressure began to bear on the largest property enterprises. Evergrande, a key player in the Chinese property market and at one point the most valuable property company in the World, defaulted on its debt in 2021, and eventually filed for bankruptcy in August 2023. Country Garden, another leading property firm, saw its shares suspended earlier this year. The company has also defaulted on loans and is facing a liquidation petition.

Concerns over the impact that defaults could have on the strength of local and national banks remain,  although the immediate prospects of a property-led banking crisis now appear less likely. China’s Government have announced a raft of measures in an attempt to arrest the decline, including the purchase of unsold homes by local authorities, although further action will almost certainly be needed to help boost confidence in the sector. Any such moves would be welcome; however, we expect the property sector to be a drag on growth for some time to come.

Transition to tech

The increased focus on new industry, such as electric vehicles, is a good example where Chinese companies have the potential to dominate global supply. A slow but steady move towards net zero will require change on a colossal scale, and a gradual move away from traditional manufacturing to added value could halt the decline in industrial production seen over recent years.

Good value for the patient investor

The poor performance of Chinese Equities since 2021 has led to valuations becoming increasingly cheap when compared to other developed markets. Estimates of the forward price to earnings ratio suggest that the MSCI China Index stands at between 11 and 13 times earnings, which is roughly the same level of market valuation as the UK, despite the fact that China is likely to grow their economy at more than double the pace of the UK over the next five years.

Despite the apparent inherent value, investment in China is not without risks. Continued pressure from the ailing property sector, ongoing tensions with the West and the potential for regulatory interference temper our enthusiasm, and given the outflows seen from Chinese Equities over the past two years, investment at this point would be considered a contrarian move.

Taking all factors into consideration, we see the potential for a rebound in the fortunes of Chinese Equities over the medium term. Investors will, however, need to show patience, and volatility may well be uncomfortable at times. We therefore feel that an allocation to China could be appropriate; however it is important to hold a diversified portfolio of assets, and our experienced team can provide advice to tailor your portfolio to suit your tolerance to investment risk, whilst ensuring diversification is maintained. Speak to us to start a conversation about the asset allocation within your investment or pension portfolio.

Sources

1 World Bank Group

2 National Bureau of Statistics of China

Jun 20
0

Is the hype over AI justified?

By | Uncategorised

One of the dominant trends that have contributed to the strong equity market performance over recent months has been growing enthusiasm for the potential that Artificial Intelligence (AI) can bring, and how companies can take advantage of the rapidly evolving technology.

What is AI?

AI is technology that enables computer systems to simulate human intelligence, with the aim of solving problems that would otherwise require human intervention. AI algorithms aim to model decisions that humans would take, by undertaking research and evaluation, and can learn from outcomes, so that the results improve over time.

Although the concept of AI can be traced back to the 1950s, significant advancement in AI capability has been seen very recently. Rapid acceleration in the efficiency of so-called Generative AI, which can produce anything from speech recognition to images and text, has seen applications such as ChatGPT being used by over 100 million users every week1. Unlike traditional AI systems, which are typically used for data classification and prediction, Generative AI models learn from large datasets, and have the ability to learn and then create new content, from realistic images to speech and writing.

The investment case for AI

Businesses that adopt AI are discovering ways to harness the new technology to streamline operations, introduce greater efficiency and in turn boost profitability. For example, in healthcare, AI can help speed up drug research and provide more accurate diagnosis. Another common example is the use of chatbots and automated customer services, which can learn from responses to become more efficient.

Investors often look for developments that can disrupt the status quo and lead to new opportunities, and it is increasingly apparent that AI will continue to be highly disruptive to existing ways of working. The breadth of application of the new technology is impressive and over coming years we suspect AI technology will find greater use in a diverse range of businesses, from finance to vehicle manufacture.

Enabling AI

Whilst many companies can see efficiencies from the use of AI, businesses that provide the infrastructure to enable AI usage have been amongst the biggest gainers over the last few months. The company that may have been able to monetise the boom in generative AI more than any other is Nvidia. As the need for processing power increases, the graphics processing units developed by Nvidia are in high demand, which has helped propel the market capitalisation of Nvidia to $3.3tn, overtaking Microsoft to become the largest quoted company in the World2. Microchip manufacturers, such as Taiwan Semiconductor, have also benefitted from the increased demand for AI solutions.

Other mega-cap tech companies have benefitted from the advancement of AI technology. Google and Microsoft have integrated AI technology into search assistants and the use of cloud computing in AI applications have boosted revenue received from cloud based servers. Recently, Apple have announced the integration of OpenAI into their Apple Intelligence system which will be available on Apple devices.

Universal adoption?

If you consider the very wide range of applications that could potentially benefit from AI technology, it is increasingly clear that most businesses will look to some form of AI integration within their systems over coming years. Customer facing functions, such as website chatbots and automated phone call handling, are becoming increasingly common, and as technology evolves, may lead to business efficiencies across most industries. For example, manufacturing businesses may harness AI technology to streamline inventory management, and help decision making. Similarly, Insurance and Finance businesses are increasingly turning to AI to help detect fraud. Those companies who have adopted AI at an early stage may gain a competitive advantage, which is likely to lessen over time as more and more businesses harness the evolving technology.

An overheated market?

Investors with long memories will recall the end of the last century as being a time when market interest in technology companies reached fever pitch. Known as the “Dot Com bubble”, the value of many technology stocks during 1999 and into early 2000 was driven to totally unrealistic levels based on the premise that they would be able to capitalise on the boom in web based applications. Whilst a select few companies justified their lofty valuations, many did not, and as investor risk appetite waned, sharp falls in value were seen across much of the sector.

Despite the strong returns achieved by a number of stocks involved in AI over recent months, it is possible to draw a distinction between some of the pure speculation that was apparent in 1999 and 2000 when the tech bubble burst, and the returns that have been fuelled by the growth in AI. Firstly, positive earnings reports from tech giants such as Nvidia and Microsoft continue to offer some support at current valuation levels. Simply put, if quarterly earnings continue to beat estimates convincingly, valuations become less demanding; however, expect stock valuations to be punished if future earnings fail to deliver.

The second clear distinction between the current tech rally and 1999 is the diversified nature of businesses that are benefitting from the growth in AI. Whilst it is quite easy to identify the companies at the forefront of AI technology, it is likely that a wide range of companies across different sectors will be able to achieve efficiencies and cost savings through AI use.

Finally, mega-tech giants such as Apple and Alphabet are highly cash generative and profitable. This is in contrast to many companies that were swept up in the dot com bubble, who were many years away from profitability and typically carried high levels of debt.

The conclusion we draw is that AI stocks are certainly not cheap on a historic valuation basis. Continued earnings growth may well support valuations; however, any signs that earnings disappoint when compared to market expectations will leave valuations exposed at current levels.

Why it is important to diversify

Market attention has been focused on the AI-fuelled rally in tech names that has driven global equities markets forward over recent months; however, formulating an investment strategy that focuses on a single trend introduces additional investment risk. Building an investment portfolio that encompasses new trends such as AI, together with other, more traditional, industries, can help reduce volatility. Speak to one of our experienced advisers if you would like to discuss your exposure to the AI trend, or to review an existing portfolio.

Sources:

1 OpenAI.

2 Companiesmarketcap.com.

Jun 13
0

The impact of rate cuts

By | Financial Planning

Decisions taken by central banks have been one of the main drivers of global market direction over recent years. Following the outbreak of the Covid-19 pandemic, interest rates around the World fell to ultra-low levels as policy makers attempted to stimulate demand amidst the global lockdowns. Just over a year later, interest rates began rising across Western economies to combat an inflationary spike, that saw UK Consumer Price Inflation (CPI) peak at 11.1% in October 2022.

As expected, inflation has fallen to more modest levels in most Western economies, and the UK is no exception. In the 12 months to April 2024, CPI has returned to 3.2% and is expected to continue to fall over the course of this year, potentially moving lower than the Bank of England’s own target of 2% by the autumn, although risks remain that inflation could modestly rebound in 2025.

Given the expected course of inflation, pressure is mounting on the Bank of England Monetary Policy Committee (MPC) to reduce the cost of borrowing and ease the burden on households and business alike. Of course, inflation isn’t the only indicator that the Bank are closely monitoring. The UK returned to growth in the first quarter of 2024, and GDP growth expectations have increased for the remainder of this year. Recent unemployment data was worse than expected and retail sales for April were very disappointing, suggesting consumer confidence remains weak. Understandably, the Bank do not wish to cut rates substantially, only to stoke the inflationary fire once again.

On balance, taking recent data and central bank comments into account, there is a large consensus that base rates will be cut in the next quarter.  Indeed, at the last meeting of the MPC on 9th May, two members of the Committee, including the deputy governor Sir David Ramsden, voted to cut rates by 0.25%, with the other seven voting to keep rates on hold.

Source of Data: Bank of England

Bond markets are already beginning to price in a series of rate cuts over the next 12 months, with yield curves implying one or two cuts to the base rate in 2024. The outlook for rates has impacted the mortgage market, where lenders have been making modest cuts to five year deals, and in fixed-rate savings bonds, where rates being offered on one and two year fixed-rate bonds have also fallen from their peak.

The impact of rate cuts

When interest rates move lower, media focus will be targeted on the impact of the cuts on households. The outcome of falling interest rates on household budgets is generally well understood. For those with variable rate mortgages and loans, cuts in the base rate could lead directly to a fall in interest payments on a monthly basis. In turn, this could have a positive impact on discretionary expenditure, and lower rates could also encourage consumers to take on credit, from mortgages to car and personal loans. Consumers also feel more comfortable carrying a higher debt burden when interest rates are lower.

Those with savings begin to see a fall in the interest they receive on their variable rate accounts, and this may encourage those with accumulated savings to spend, potentially providing a boost to economic growth.

What is less understood is the significant impact underlying and future interest rates have on business, and in turn the health of the economy. Whenever the base rate changes, this affects the rates charged by banks on commercial loans, which tend to be arranged using a variable interest rate. The rapid succession of rate increases from the end of 2021 to August 2023 not only raised interest costs on existing business borrowing, but also has the effect of deterring businesses from taking on additional debt, further suppressing economic expansion.

How markets may react

Monetary policy decisions taken by central banks are one of a number of variables that dictate the progress and direction of financial markets. Cuts to base interest rates are generally perceived as being positive for both equities and fixed income securities. Equities benefit as companies can reduce their borrowing costs and more easily fund expansion. Depending on the sector, company profits may also benefit from more buoyant consumer confidence. Those companies who carry the highest level of borrowing tend to benefit the most from falling interest rates, which helps explain the recent strong performance of high growth companies, such as those involved in new technology, who tend to be highly geared.

The performance of bonds is directly linked to the future path of interest rates. As base interest rates increase, existing bond prices tend to fall, as investors can choose other options that offer a higher rate, such as newly issued bonds, or cash. The rapid increase in base rates during 2022 and 2023 proved to be very painful for bond investors, and saw bond prices retreat. The inverse is true when rates fall, as existing bonds offering higher rates look increasingly attractive compared to cash or bonds issued at a lower rate.

It is important to note that markets are forward looking, and have long been anticipating interest rate cuts in the US, UK and Eurozone. Indeed, markets have been frustrated by the slow march toward the expected rate cuts, although some of the concern has been offset by consistently stronger US economic data over recent months. Some of the positive impact of easing monetary policy has, therefore, already have been taken into account.

What action should investors take

As interest rates fall, investors would be wise to consider reviewing their existing financial arrangements in light of the changing landscape. Whilst cash has provided savers with attractive interest rates over the last 12 months, it is likely that savings interest rates will fall over the next two years, and those holding excess deposits on cash may do well to consider alternative options.

We feel a falling interest rate environment should prove positive for both equities and bond markets, and despite the strong performance seen since last autumn in anticipation of central bank action, the prospects over the medium term remain positive. Given the expected impact of a shift in monetary policy, this may be an ideal time to take another look at how your investments are positioned. Speak to one of our experienced financial planners to discuss the impact of falling interest rates on your investment portfolio.

Jun 06
0

Get the right advice when approaching retirement

By | Pensions

Each major financial decision that we take throughout our lives will have some form of impact on our financial wellbeing. From the decision to purchase a property and take out a mortgage, to changing careers and other life events, such as divorce or receipt of an inheritance, the choices we make will have some impact on our financial future. Perhaps the most crucial decisions, however, need to be taken when we approach retirement, as actions taken at this time can have lifelong implications. This is where tailored and personal advice on the options open can prove highly beneficial in navigating the right course to take.

Pension Options

As we head towards the end of our working lives, thoughts inevitably turn to the level of income that we can look forward to in retirement, and pensions are likely to form a substantial part of your income when retired.

The full rate new State Pension is now £221.20 a week, although you will need to have accrued 35 years of qualifying National insurance Contributions to receive this amount. It is worth checking your State Pension record with the Department for Work and Pensions, as this can identify any gaps in your record that could be filled before reaching State Pension age. This is currently 66 but will rise to 67 for those born after April 1960, with a further increase to age 68 between 2044 and 2046.

Many individuals would prefer not to work until State Pension Age, and this is where careful planning at an early stage can help you assess your options and make best use of private and workplace pensions accrued during your lifetime, which could, in turn, make earlier retirement feasible.

Taking the time to review existing pension arrangements at an early stage can help identify poor performing investment funds, or recognise opportunities to increase pension saving, which could boost the end value of the pension plan as you reach retirement. It could also provide an opportunity to consolidate and rearrange plans, if appropriate, to benefit from cost savings or access the widest range of options when retired.

When taking a defined contribution pension, it is usually the case that 25% of the value will be available as Tax Free Cash. This is the first of many decisions that need to be reached. Some may decide to use the Tax Free Cash payment to cover existing debts or pay for discretionary expenditure. Some plans allow you to draw Tax Free Cash over a period of time, rather than in a single payment. Depending on the retirement strategy adopted, this could be an effective way of generating a tax-efficient “income” through regular Tax-Free Cash payments.

Deciding on how to draw an income in retirement is a key decision that many find daunting. Many choose a Drawdown approach, where the pension fund remains invested, and income is drawn flexibly to suit your needs and objectives. If funds remain invested after you die, these can normally be paid to a nominated beneficiary. The risk with drawdown is that the invested pension fund is fully depleted during your lifetime, and this is where regular reviews of the investment performance and amount of income drawn are important.

Purchasing an annuity, where the remaining pension is exchanged for a guaranteed income for life, is an option that some prefer, given that this provides a degree of certainty. The downside is that the purchase of a lifetime annuity cannot be reversed, and therefore careful consideration of the benefits and drawbacks need to be taken into account.

The final option is to take out the pension value as a single or series of lump sum payments. Taking this option is rarely sensible, as it will leave no ongoing pension income, and could potentially lead to adverse tax consequences.

Other Income sources

For many individuals, pension income is built from several sources, and whilst pensions form the majority of retirement income, other income streams can help support ongoing living expenses. Some may hold property that is rented out, which provides rental income, which may well be reliable, although such income is normally not tax efficient.

Many individuals hold existing investment accounts outside of a pension. Undertaking a review of such investment plans could prove beneficial in determining whether an income stream can be generated. Use of the annual Individual Savings Account (ISA) allowance can help ensure income is received free of tax.

Finally, some continue to work past their normal retirement age, or look to adopt a phased retirement approach of gradually reducing hours, whilst building up pension income slowly. This can be an effective way of managing income and leaving pensions in place to potentially benefit from further growth.

Watch out for tax

We are all taxed during our working lives, and many will continue to pay Income Tax on pension income throughout retirement. There are, however, steps you can take to look to reduce the tax burden in later life. For example, where income is generated in a flexible manner, the level of income can be tailored to meet your precise requirements without surplus income being generated, on which tax becomes payable.

Seek out personal advice

Planning for retirement is a point where important decisions need to be taken, and  seeking independent and tailored financial planning advice at an early stage is therefore advisable. Every individual’s circumstance, needs and objectives are different, and other variables, such as your attitude to investment risk and personal preferences, are key factors in reaching the right decision for you.

Speak to one of our experienced financial planners, who can help guide you through the retirement planning process.