“Even the highest tree has an axe at its foot”- Ian Fleming- From Russia with Love.
1. The broken retirement pot: Asset values and volatility.
2. Who is holding the hammer?: Blame the Russians?
3. Rising prices: The symptoms in need of treatment.
4. Solutions: Portfolio management in a crisis.
1. The broken retirement pot- asset value and volatility.
“Even the highest tree has an axe at its foot” (Ian Fleming- From Russia with Love)- this month's big news from the office relates to the absolute horror of several clients observing their Q1 2022 valuations -something highly personal has happened to them. Whilst consequences are personal the causes are not. The horror is global and with heightened awareness delivered by new protocols from portfolio platforms that advise clients when valuations fall over 10%. The current asset allocation crisis is a COVID-like phenomenon with roots in the global economy. In the March 2020 COVID crash, the S&P 500 (a key benchmark for USD growth assets) eventually weathered the storm as the FAANGs eventually provided portfolio protection from a disease that impacted the entire world. Q1 2022 has got a lot of the Q1 2020 feel about it.
The story for today “stay calm, stay invested” remains great advice……. but this is not the same advice as doing nothing!
How broken is the pot? From an asset allocation standpoint, we review the three main correlated assets: equities, bonds, and cash. We take the S&P 500 being more than 50% of global growth assets to tell the story. In Diagram 1 we show the S&P 500 in a raging bull market from 2012 to the end of 2021. Indeed, the last US recession followed the Global Financial Crisis (GFC)- 2007 to 2009, and investing in US-denominated growth assets for the last 15 or so years has been “heavenly” ….until now? In Diagram 2 “Timber” we show that the S&P has lost nearly 14% YTD as at the end of May.
Diagram 1: The mighty oak- “buy, hold, relax”.
Diagram 2- “Timber”- S&P500- YTD 2022 (Yahoo finance)
In a textbook crisis, we could jump from equities to bonds and other fixed interest assets in anticipation of gathering income to replace either or both purchasing power and capital loss. Yeah, well, the problem with textbooks is that the word “unprecedented” – (being one of the more common asset manager explanations since the GFC) has been so well used that it renders the textbook impractical. A textbook is a thing of empirical study, surviving many “unprecedented” events is a thing of being in the moment which we describe within our solutions. Current cynicism is driven by equities and bonds failing at the same time because interest rates are set to rise. Economics 101: when Interest rates go up, bond values go down. Capital protection from bonds has no near-term value. For our textbook to gain credibility we need coupon/interest rates to be at around 8% in places such as the UK and the US to protect purchasing power.
In Diagram 3- Central Bank Interest Rates 2022, the nature of the problem is laid bare. Big returns go with big risk, the Russian rate at 11% has competition from Latin America. In the so-called “Risk-Free Rate” territory (which is actually the 10-year numbers- but the point holds) US and UK rates are at 1%, the Euro at 0%, and the Japanese and Swiss won't even give you your money back. In short, with miserly returns on debt and cash, and volatility rampant on equities, we can conclude: that the Retirement Pot is- currently- broken. Skip to “Solutions” in section 4 for bandages.
Diagram 3- Central Bank Interest Rates 2022 (Global-Rates.com)
2. Who is holding the hammer? Blame the Russians?
In Joe Blogs excellent YouTube economic analysis- he virtually blames “The War” for a role in most of our current global economic crises. He was accused of putting the word “Russia” as a headline grabber for all problem areas: Pakistan, Sri Lanka, you name it. His reasoning- whilst not all down to Russia- a lot of it is. The bottom line is this: we all know gas and oil prices have escalated since the 24th Feb invasion- “and this is now feeding through into the pocket of consumers”. If you haven't felt it yet- it’s coming to a shop near you soon! Here is a summary of Joe Blogs May 29th overview:
The cost of living crisis effects all of us…. “it's going to get worse over the next 12 months” or so.
Gas and oil prices have risen by over 50% since the start of the war. In some areas the government has shielded consumers to some extent by capping prices and subsidy schemes, maybe windfall taxes on the profits of private companies will follow.
People are NOT getting paid 50% more than they were a few months ago. Less disposable income. Less fun.
Everybody needs energy and fuel for their everyday existence.
Increases in energy costs (electricity and gas) effect the poorest people in society disproportionately. We all pay the same price at the petrol pump, but the poorer you are the higher the impact on your budget. We all pay the same price for energy.
With winter coming in the Northern Hemisphere- where will the energy price fall come from?
OK- we know that Putin can’t be blamed for COVID, for the logistical supply chain issues arising from the disease, and the lockdown strategy in China. All of these have been major contributions to the inflationary spiral. What we can say- is the effect of The War on energy prices is such that we can conclude there is not a lot of love coming out of Russia as far as the global economy is concerned. And we haven't got into the predicted food shortages yet.
3. Rising prices: the symptoms in need of treatment.
We have used our Newsletter space before to measure the impact of inflation as it has worked its way up the worry charts. Diagram 4 helps us with a “worry-o-meter”.
Diagram 4- The Global Inflation Outlook IN 2022 (Statista via the IMF)
Whilst inflation is not a fully global issue (yet) and with The Gulf States seemingly in the blue relaxed territory- (no need for large rent rises then?) we can see that the dominant colour is red. In retirement speak red is the worry colour.
With the US at over 8% p.a and pink but approaching deep pink, and with much of Europe in pursuit, the effect can be calculated with a re-visit to the Rule of 71.8.
What is The Rule?
We use it in this piece to calculate the effect of inflation on purchasing power.
Take the current inflation rate in your base currency (the currency you are going to do your purchasing with).
Divide the inflation rate into 71.8 to tell you how many years it will take for your purchasing power to erode in half.
For the US economy, the inflation rate was at 3% (most of 2020) meaning that purchasing power would erode by half over around 23.9 years. Fast forward to the May 2022 rate (8.8%) and that 50% fall occurs over 8.1% years. That has a massive impact on retirement calculations and the probability of capital failing to outlive the life of the retired non-earner.
4. Solutions: Portfolio management in a crisis.
Here is the trick about managing a crisis: understand it. We pull on 3 pieces of advice to consider during the current inflationary crisis which will not disappear soon.
4.1- ADVICE PIECE No1: The best way of taking risk and enjoying volatility.
Visit the sales- and drip income into a bear market.
The first thing to note is the appreciation that much sound investment advice is counter intuitive. This understanding separates the inexperienced investor from the professional investor. Warren Buffet is the world's most famous professional investor. The “Sage of Omaha”, he who wasn’t born rich, suggests that despite all of the above his way out of the current inflationary crisis is to “buy, buy, buy”- the advice relates to equities.
Clearly, counter-intuitive to many because whilst inexperienced investors will race to the shops to buy during “The Sales”, they don’t seem to rush with the same enthusiasm when it comes to investing. Diagram 1- is one of many suggesting that whatever the “unprecedented” event, prices will revert to mean. Markets- currently fearful- will get greedy again.
The best way to do this is the much-vaunted “drip-feed” of cost-price averaging by buying regularly (typically monthly) into markets. Here market “trackers” come into their own. The Law of Survivorship ensures that the market retains the survivors and loses the failed businesses that events might provoke.
4.2- ADVICE PIECE No 2- : Cash management.
Cash is a means of exchange and a store of value. At times of low inflation and low interest rates- the role of cash in financial planning recedes. Indeed, we have been advising clients to hold over-drafts in their portfolios if they are paying (say) 1% for it on the basis that remaining invested rather than paying the overdraft off is good leveraging.
As inflation rises and as Interest Rates rise (as they must) then the cost of debt increases. Also, the need to separate the asset which provides a “means of exchange” function from medium to long term investment increases. We must concentrate on our emergency cash reserves.
In short, we can't apply the “buy, buy, buy” equities logic to the need for cash to pay the energy bills, to put the food on the table, and to buy fun, for the fun things which are not free. This means that financial planning must have an “Emergency Cash” quota. Important even if it is only a lick-finger-stick-in-air subject rather than a science-based calculation. Broad delineations might include:
Current medium/long term employed: suggest something like 6-months emergency cash. The job should dictate the length of time. A brain surgeon and hotel manager will apply different assumptions.
About to retire in the next 5 years: At Mondial, we call this the “pre-retirement years”. It is time to start thinking about adapting your portfolio to the assumption that, when you retire, you still have a short, medium, and long-term future. Building towards 3 years (or so) of cash on retirement AND maintaining risk assets is the balancing act.
In retirement: This is the time, when, having finished the race, you might wished you had run faster. Still- you are where you are. You still have a short, medium ad long-term future. The biggest failure we see here is in keeping the same risk profile for the short and medium to long term. Balancing the portfolio remains the priority – it is simply more important.
4.3- ADVICE PIECE No 3: The best way of protecting capital from downside risk.
Passive versus active management.
Let's get back to that word “unprecedented” again. If markets were predictable and upwardly mobile as in Diagram 1- there would not be a massive need for research and active management. A much-used adage in the office is “Any fool can make money in a rising market”. What do you do when markets are not rising? In terms of protecting capital, Mondial's go-to advice for the forthcoming crisis will be to stick with multi-asset managers for both research and diversification. They have the ability to "live in the moment" and to adapt to changing circumstances. Change being a certainty in the current times.
What research does that passive investment cannot includes:
Undertaking due diligence on illiquid assets and absolute return funds which the average (even experienced and sophisticated investor) does not have the skill or the time to undertake.
Find alternative investments which can replace some growth-orientated assets- i.e., infrastructure, commercial real estate, and the like.
Use research to find the best stocks and the best stock weighting for risk-managed portfolios.
To weigh up the best stock picking strategies from recession to recovery
Use research to find the best inflation-protected debt assets.
Balancing , and continually re-balancing all the above into one portfolio and managing the weighting against events as and when they might occur.
Yes, active management fees are more expensive than passive. Our counsel for at least the next year or so- is PAY THE PRICE. Increasing the expense of investment to reduce the downside losses is eminently sensible and the best advice for the protection of capital in current markets.
We argue that the price of a Holistic approach to a plan would remain a low expense rather than simply comparing the cheap passive costs versus an extra 1% (roughly) on active management- because:
Advice area 1- take risks- use inexpensive, equity market trackers.
Advice area 2- calculate your cash management needs- the cost of which is the time to think and plan.
Advice area 3- Protect capital- pay the fee to experts doing the thinking and research for you.
For more details, or to contact Sean Kelleher CEO, Mondial Dubai LLC,
please contact us at
+971 56 2228 535