Review your investments – consider China

The Presidents of the USA and China talking

I believe that there is good reason for you to review whatever investments you have now. I want to make an important point and I hope you will bear with me as I get to it!

What is your attitude to risk and capacity for loss?

It is important that your investments are matched with your attitude to risk and your capacity for loss. 

  • Capacity for loss: This is best understood by thinking of the time that is left before you will need to take a large sum from your investment. For example, if you will need to remove a large sum from your investments (or indeed all of them) within the next year or two then you will naturally have very low capacity for loss.  In other words if your investments fell in value by say 20% in the next year or two that could mess up your plans for the money you want to withdraw. 

  • If you are not expecting to take a large sum from your investments during the next 7 to 10 years, except for perhaps monthly withdrawals of no more than 3%, then you will naturally have a higher capacity for loss.  Of course even if you have a long term timescale if losing any of your capital will greatly upset you then you will have a low capacity for loss in any event.

  • Attitude to risk: This can be identified on a simple scale of 1 to 10 where 1 is very cautious or risk averse, and 10 is very adventurous. Risk level 5 would be called balanced or moderate. You need to match the combination of your capacity for loss and your attitude to risk to the right risk investments. 

  • So if, for example you have a moderately adventurous attitude to risk but only a medium capacity for loss you will want to use a balanced or moderate investment portfolio overall.

That’s the background so what is the point I am trying to make?

My own investments and pension funds have been held in a fairly adventurous portfolio (risk level 7). I have now moved all of my investments into a balanced portfolio (risk level 5).

Please bear with my while I try to briefly explain why I have done this and why I believe you should review your own investments.

The following chart produced by the World Bank for the period 1970 to 2018 shows that global personal debt (the yellow line) and global government debt (the red line) have continued to increase over the last 50 years only hesitating for a moment during the 2008 global financial crisis.  As a result of this the world economy is quite fragile because growth in output has been relying on increasing indebtedness.

Whilst this is a source of concern there is one country in particular which is now the main driver behind this increasing indebtedness.

In the following chart from the World Bank the blue line labelled EAP is China and you will see that their debt as a percentage of their gross domestic product (GDP) is getting out of hand. In fact the rate of increase in their debt is unprecedented. What is worse is that the money raised has generally been misspent within China.  They have built roads to nowhere, houses that no-one lives in and they have an incredibly corrupt economy.  China has over-expanded and will now have to go through a period of slowdown.

It is clear that Covid has been a catalyst to a major change in the world order. China has a $400 billion trade surplus with the US and under the present US government this is no longer going to be tolerated.  China has for decades simply ignored intellectual property rights and other countries are becoming increasingly cautious in trying to sell their products, particularly high tech products, to China because they see that they are simply giving away their expertise and creating a strong competitor for their business in the long term. 

China itself is showing signs of stress as evidenced by its increasing aggression towards Hong Kong and countries along its borders..

This leads to the conclusion that China rather than Covid will be seen as the number one problem to the world economy in the months and years ahead. Together with the catalyst of Covid it would be prudent for any investor to prepare for a reduction in global economic growth.

This will have two effects which could potentially have the greatest impact on your investments: 

  • Higher risk portfolios: We could be about to enter a turning point between growth stocks and value stocks.  Value stocks are typically those companies that have been unloved by investors who have seen them as rather staid, preferring instead growth companies that have been racing ahead.  As the turning point occurs then markets could fall well below what they are today causing a loss of capital for those invested in higher risk, essentially growth orientated, portfolios.

  • Lower risk portfolios: We could see Western countries, particularly the US and Europe, starting to wrestle back manufacturing from China as it becomes clear that China is not playing fair as a trading partner.  This would mean that wages in Western countries will increase bringing with that the significant threat of higher inflation.

This will be a big problem for those invested in lower risk portfolios which rely heavily on fixed interest Government (i.e. gilts) and corporate bonds.  This is because fixed interest investments lose capital value during periods of increasing inflation. Bear in mind that inflation as measured by the Consumer prices Index (CPI) is currently only 0.5% pa.

There are those over the years who have advocated investing in gold during such market uncertainty but gold is really an alternative currency and not a true investment.

My point is that this could well be the end of an economic growth era and that we should not expect assets which have previously performed well to do so in the future. Most importantly we should not be complacent about the markets which have been somewhat unreal of late and have held up well in the face of the changes being brought about by Covid.

Equities are not down and out and I am sure they will recover over the longer term but if you cannot take a 7 to 10 year view with your investments then you need to take a look at the level of risk you are taking with a view to adjusting it now if necessary. 

So what am I suggesting you do? 

Simply review the risk you are taking with your investments. Are your investments described as very cautious (somewhere between 1 and 3) or adventurous (somewhere between 6 and 10)? 

If you are not sure I would be happy to use the tools that I have available to tell you what level of risk you are currently taking.

  • If you are taking a reasonably high risk (risk levels 6, 7 or 8) then are you happy to take a long term view? If not then now could be the time to reduce that risk.

  • If you are taking a particularly low risk (risk levels 1,2 or 3) then again please review what a higher level of inflation might mean to your returns.  This is particularly important if you currently (or are intending to) take regular withdrawals from your investments. If that is not an issue for you then all well and good.

These are, of course, views that with hindsight, may prove to be wrong. However, after all of my years in the business I have been convinced that this is important enough for me to have taken action with my own and my family’s investments. 

Having done so, I felt that it is only right to pass on my concerns to you and to invite you to review your portfolios.

Arthur Childs

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