It's the end of the world as we know it........

Given events in the world's financial markets since the start of 2016 we could be forgiven for hearing the words to the famous R.E.M song ringing in our ears. However, if you are a regular reader of my blog you will know that The Spectrum IFA Group holds an Annual conference at the start of the year and in 2016 it was Venezia.  This is where we try to make sense of 'end of the world' prophecies. Since the start of 2016 and up to the day of departure for Venezia, stock markets had fallen between 8 and 15% globally and Brent Crude Oil was down 20%. So it was important to understand the current volatility in world economics/markets and is it likely to continue, or if we really are teetering on the edge of the Mariana Trench without air. The Spectrum IFA Group has a strong reputation in the International financial services sector that allows us to access resources from some of the biggest and best names in our business and they all presented fairly similar views on where we are and where we might be going. This can be summarised in 5 main trends for the year ahead. OIL, CHINA, INTEREST RATES, EMPLOYMENT and BREXIT.  So let me ask you a question! Do you believe that there is a global recession around the corner?  We DON'T! Is this current economic environment similar to 2008 just before the near collapse of the world's banking sector?  We DON'T think it is!  The state of global economy is not perfect (it never is) but it is not that bad either. So let's take a close look at these themes in brief

OIL

Clearly the main theme at the end of 2015 and the start of 2016 was the drop in the Oil price which from its high has now fallen approx 70% in value.   Initially there were worries about the economic slow down in China which triggered a fall in the price at the end of 2015.  This was closely followed by worries that since OPEC had agreed to keep production at their current levels, the world would be swimming in a glut of oil. And this is exactly where we are at.  The world has an oversupply of Oil. The drop in the oil price is being driven mainly by a geopolitical game of 'who will blink first' and cut production to bolster prices.  I am sure you are aware of oil fracking in the USA. (a questionable activity if I do say so myself) The amount of oil that the USA can obtain through fracking can keep them self sufficient for many years to come.  This is a worry for Saudi Arabia who have traditionally being the largest exporter of oil to the USA.  By creating oversupply the oil price has fallen.  The hope is that it will put many of the US fracking companies out of business.  However, the cost of extraction by fracking has fallen dramatically from $110 a barrel to $34 a barrel and so even at the current price, oil production in the USA can afford lower prices for longer.  However, other countries must also keep production high just to support their revenues.  They can't afford to stop pumping even at these prices.  Nigeria and Venezuela have already met with OPEC to explain that they cannot wait until June (the next OPEC meeting) with current oil prices at these levels.  Russia has lost 4.5% of its gross domestic product as a result of the low oil price.  THIS ALL BEING SAID, 2015 WAS THE HIGHEST YEAR ON RECORD FOR OIL CONSUMPTION GLOBALLY.  (I WAS ALSO SHOCKED TO LEARN THIS FACT!).  AND IT IS STILL INCREASING!  SO HOW LONG WILL THIS OVERSUPPLY LAST?  Lastly, on this subject it should be mentioned that low oil prices, whilst not favouring the renewables sector (unfortunately), can help consumption led economies by putting more money in the pockets of the average person (China, Europe, US and Japan) and therefore stimulate spending and growth. So is a low oil price really that bad?

CHINA

There has been a lot of talk about China recently and its economic slowdown and it was a big topic of conversation at our conference.  However, I find it is often necessary to make our own observations, where possible, and Venezia gave me the perfect chance to do so.   Whilst there, Thursday evening to Mon AM, I happened to take a number of strolls through the centre and a trip on a boat around the lagoon. You could be forgiven for thinking that Venezia had been invaded by China.  The majority of people in the city were Chinese.  In our hotel the breakfast bar was 90% Chinese, on my train home I was in a full carriage with 3 Europeans and the rest Chinese. They were all carrying bags of various European brand name articles, from designers to art work.  They were also dressed in Western designer brands.   Despite China taking on as much debt in the last 5 years as the US has in its entire banking sector, there is nothing to suggest that the economic situation is getting any worse in China. Their biggest issue is moving from a manufacturing based economy to a services based one and at a rate that can support their economic needs.  It is believed that the majority of the slowdown is now behind them and that the economy will likely grow between 3.5 - 5.5% annually for the next 10 years.   From a protection of wealth point of view, whilst the short term equity market outlook might be negative and volatile, from the current position of their stock market based on historic data, (once again), Blackrock told us that at these levels positive returns have been positive 83% of the time on a 1 year basis and returns have been positive 90% of the time on a 3 year basis.   So is China still a good place to invest?

INTEREST RATES

The main message from all the fund managers at the conference, regarding interest rates was that they are not this years problem.  What they meant by this was that whatever decisions are taken today, with respect to interest rate increases or decreases, they will not show in economic data for approximately 18 months.   So decisions on interest rate rises in the USA or UK are no real indicator for us now.  Therefore, we should pay little attention to confusing reports about the effect on markets. That being said we can assume from historic data that there will be some effects on financial markets from an interest rate rise. (The USA is expected to raise rates again in March 2016, the UK in August 2016 and the markets are already pricing in a rate rise in the EU of 0.11% by 31st Dec 2016) Taking this into account data in the USA shows us that from 1971-2004, that the average return in equity (share) prices in the year BEFORE an interest rate rise was 10.8%.  (This would concur with a market rise of approx 11.4% in 2014).  In the year AFTER an interest rate rise the average equity market return has been 12.9% and 2 YEARS AFTER, the average equity market return is 19.2%..  So what will 2016 hold (which is 1 year after the interest rise in 2015). Clearly, this is based on historic data but could indicate that 2016 may not be such a bad year in equity markets, after all.  (If you have a crystal ball and can see the future, please let me know or just invest wisely) Whatever the outcome for equity markets, rising interest rates in the West will mean more volatility, so returns may come at the price of increased uncertainty.   And as for the rest of the world, it is assumed that the EU will keep on  with their quantitative easing programme as they are 2/3 years behinds the USA and the UK.  Japan will do the same and China may reduce rates in an effort to stimulate growth.

EMPLOYMENT

The employment situation can be summarised very quickly.  Conditions are right for wage growth, especially in the US and the UK, where unemployment has fallen a lot faster than expected. If wage growth starts to come through then individuals tend to spend rather than save (unlike companies) and this can lead to price inflation and further growth. As an example of this, in the UK, wage price inflation grew approximately 4% last year in the private sector and a lethargic 2% in the public sector.

BREXIT

For myself and many other Brit's living outside the UK, this is clearly the most worrying factor for 2016.  Apart from the fact it could have significant consequences for British individuals living in the EU, there was much talk in Venezia of the momentum surrounding the campaign at the moment.   From those who live in the UK, the current consensus of opinion is that the 'OUT' campaign is gaining ground and that it has become a real possibility. However, we also have to be rational and understand that should a 'NO vote win the referendum, then the implications of this will only be realised through, an expected 2 years of protracted negotiations. There is also the possibility of a Hard exit or a Soft exit.  Will the UK be able to negotiate to keep existing  privileges with the EU or will the exit signal a  harder stance from the EU and barriers to trade be erected?    Whatever the outcome it will take some time, probably years, to work out the details so worrying about the initial outcome is futile at this stage. What is more important is:  1  If you are eligible to vote in the forthcoming UK referendum, (you have NOT been registered as non UK resident for 15 years or more) but you have not registered to vote then do so.   Click on the link:  Vote to register in the UK referendum  2.  If you receive money in UK Pounds and are regularly converting money into Euro, then you may want to start thinking about the possibility of a significant devaluation in GBP in the run up to the referendum.   Global currency traders are taking the largest insurance positions they have ever done against a negative move in GBP in the run up to the referendum. If the vote would be out of Europe then you could reasonably expect that this position would slide further.

In conclusion, the overall consensus from our team of experts in Venezia was that the world is not peering into the Mariana Trench and it isn’t 2008 again. There are good shoots of growth in many markets and even with the “slow down” in China they are still a significant part of the growth in the world economy.  The world economy is expected to grow 2-3% in 2016.  ​  in 2016 we will continue to see volatility in financial markets  but we will make it through and there could be some surprises along the way.  Alternative fuels, disruptive technologies??  Since I arrived back from Venezia oil is up 7% and most markets are up between 1% and  4%!! If you would like to contact me about anything contained in this blog, tax matters or merely to review your situation for the years/s ahead then you can contact me on gareth.horsfall@spectrum-ifa.com or call me on +39 3336492356