What could the proposed changes to CGT mean for advice?

I do hope you are well and looking forward to Christmas, albeit one that I suspect will look very different from those that have gone before and hopefully, those that will follow.

As you will know, the Government has borrowed substantial amounts of money to help us get through this global pandemic, unprecedented in modern times and it will be need to be repaid – eventually. One element of taxation that the Chancellor has identified as ripe for reform is Capital Gains Tax (CGT).

I am grateful to Standard Life for the technical content that follows.

Recommendations by the Office of Tax Simplification (OTS) on the future shape of capital gains tax (CGT) could have a significant impact on investment and wealth transfer advice.

The Government requested the OTS to undertake a review of CGT in July with a particular focus on areas where the existing rules can distort taxpayer behaviour. The OTS report asks the Government to consider making changes which will have a significant impact on advice if they eventually become law.

It is therefore important for advisers to understand what changes could be on the horizon and how it could affect your clients.

The key proposals

• CGT rates to be more closely aligned to income tax rates

• Annual CGT exemption reduced from £12,300 to between £2,000 and £4,000

• CGT losses to be used in a more flexible way

• On death beneficiaries would be deemed to have acquired inherited assets at the historic base cost of the deceased rather their value at the date of death

• Lifetime gifts of assets to be on a no gain no loss basis

Aligning CGT rates with income tax rates

One of the drivers for more closely aligning CGT rates with income tax is to prevent arrangements which attempt to treat returns which are income like in nature as capital gains to benefit from lower rates of tax. But the impact will be felt across the board, not just by tax avoidance schemes.

We have previously seen gains taxed at the same rate as income tax when taper relief and indexation relief were available to reduce the amount of gain subject to tax. And these latest proposals recommend that there are similar measures put in place so that only the gain above inflation will be taxed.

The OTS was only asked to look at CGT in the context of individual taxpayers and not companies. Aligning CGT to income tax rates creates disparity between the income tax rates on higher rate taxpayers and the 19% rate paid by corporate investors.

The OTS has recognised that this may prompt growth in the family investment company market with investors able to take advantage of the lower tax rates. The OTS have suggested that HMRC put measures in place to prevent higher and additional rate taxpayers using this route to convert gains which could be taxable at 40% or 45% to 19% by setting up a company to hold the investments.

Reduced annual exemption

In addition to the CGT rate increase there is a proposal to cut to the annual exempt amount. The OTS deemed that the current £12,300 exemption is overly generous. They believe the original policy intention was to keep small occasional gains out of the need to report or pay tax.

What they found was that the exemption was being treated as an allowance whereby gains up to the exempt amount were realised each year. In their view cutting the annual exempt amount to between £2,000 and £4,000 would be a suitable de-minimis limit which would still keep most gains free of CGT.

Flexible use of losses

Currently capital losses can be carried forward indefinitely and used to offset future capital gains. But for those who infrequently realise capital gains, relief for capital losses is limited. Aligning CGT rates with income tax offers scope to open up allowing capital losses to be offset against income. And the report also suggests the possibility of allowing losses to be carried back to allow tax to be reclaimed against capital gains from earlier tax years.

CGT on death

There's no CGT payable on death and the deceased's beneficiaries are deemed to have acquired the assets they inherit at their value at the date of death. This CGT free uplift could disappear under the OTS proposals and be replaced with a transfer on a no gain no loss basis.

This would mean that there is still no CGT paid on death but the beneficiaries’ base cost for future disposals would be the deceased's historic acquisition cost. This could create an administrative issue for some beneficiaries in identifying the original base cost. To help it has been suggested that base costs are revalued to the year 2000.

CGT on lifetime gifts

The CGT free uplift on death was also deemed to act as a deterrent to lifetime gifting with the possibility of a double tax charge. This is because CGT could be payable at the time of the gift and potentially IHT too if the donor failed to survive for seven years from the date of the gift.

The OTS report suggests that the lifetime gift of assets is also moved to a no gain no loss basis to encourage the transfer of wealth between generations. This would see gains deferred until the donee disposes of the asset, something which is only currently possible where the gift is of unquoted shares or gifts into relevant property trusts where holdover relief can be claimed.

Impact on saving

These changes will undoubtedly affect savings and wealth transfer behaviour. But it is important to look beyond the headline changes to understand the true impact.

An increase to the rate of tax payable on capital gains combined with a cut to the annual exemption is not good news for savers. Savings in unit trusts and OEICs could see the rate payable on gains double. But remember that under these proposals only the gain above inflation would be taxed.

Reducing the annual exempt amount would reduce the benefit of crystallising gains up to the exemption at the end of each year. Currently using the exemption in this way is worth up to £2,460 a year for a higher rate taxpayer but if it is cut to £4,000 combined with a move to income tax rates the annual tax saving is reduced to £1,600.

The reduction would also leave little room for larger portfolios which are actively managed to rebalance assets without triggering a CGT liability. Could this increase the popularity of passive and multi-manager type funds by removing the necessity to make regular disposals to maintain the target asset class mix?

Bonds v OEICs

The proposed changes will narrow the tax gap between investment bonds and OEICS/unit trusts. OEICs are currently taxed at 10% or 20% on their capital growth, rather than income tax rates that investment bonds pay.

Income and capital gains within a bond are rolled up and no tax is payable until there is a chargeable event such as the surrender of the policy. Top slicing relief acts as a mechanism to limit tax paid at higher rates on rolled up bond gains arising in a single tax year.

This ability to defer tax can be beneficial especially if gains can be timed to coincide with a tax year when the bondholder has little or no income in the tax year. However, it can also mean that dividend income is not only rolled up with no opportunity to utilise the dividend allowance each year but also becomes taxable at 20% or 40% compared to the dividend rates of 7.5% or 32.5%.

In addition, bonds can be assigned without triggering a chargeable event, creating an opportunity to pass the bond to another family member who may pay less tax on the gain.

This has made bonds flexible when looking to transfer wealth as a similar change of ownership for an OEIC/UT is a disposal for CGT and tax could be payable unless it is a spousal transfer. But a move to a no gain no loss basis for lifetime gifts brings OEICs in line with bonds in terms of giving assets away without creating a tax charge.

There is no relief for economic losses within an investment bond but the added flexibility to carry back capital losses or to offset them against income would be welcome new feature for OEICs.

Summary

These suggested changes will clearly have an impact on both investment wrapper choice and the transfer of wealth if they become law. And if it the tax gap between bonds and OEICs is set to narrow, advice when selecting the right tax wrapper will increasingly be determined by understanding a client's circumstances and objectives.

While there are no guarantees the Government will adopt these recommendations, they do address the specific points raised by the Chancellor in his letter to the OTS.

As always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

What a difference a week makes!

After a long period of seemingly never-ending gloom, on Monday of last week we turned on our TVs to be told that the Pfizer/BioNTech vaccine trial showed an efficacy of around 90%, far in excess of most scientist’s wildest dreams - there had been talk of anything over 50% being a good result. And then, just a week later, we hear that the US firm Moderna, has developed a vaccine providing close to 95% protection against Covid. The way the financial markets have responded to this news, along with a benign US election result, you would think that Christmas has come early!

There is no denying that these results are fantastic news for us all, although I suspect, once the logistical challenges associated with vaccinating half the worlds’ population sinks in, the euphoria of the last week or so may abate somewhat but there really is a light shining in the tunnel now and life after Covid is definitely drawing closer.

With the above in mind I was very disappointed to read in Money Marketing magazine this morning that many non-advised investors had sold investments during the very worst of the pandemic.

According to the research, approximately 1.38 million retail investors sold £10,000 or more of their investments during the early stages of the crisis, and 531,900 people sold £100,000 or more of their holdings.

In terms of what people did with the funds, 59 per cent left it in cash savings, 31 per cent used it to pay for living costs and 29 per cent to clear debts.

Oxford Risk head of behavioural finance Greg Davies says: “Many of the investment decisions retail investors make are for emotional comfort, and in a normal year this can on average cost them 3 per cent in returns. Driven by the Covid-19 crisis, stock market volatility levels have been greater this year, so the losses will be higher.”

Davies said those investors who pulled money out of the markets in March will already have lost much more as they lost when the markets dropped, and many have missed out on the rebound since. “Many are also likely to find it emotionally difficult to get this money reinvested for the long-term and so may lose out on even more foregone returns in the long-run,” he adds.

The research reveals that despite stock markets having recovered much of their losses in recent months, of those investors who cashed in some of their investments at the start of the crisis, 29 per cent have not reinvested any of this money back into the markets.

Oxford Risk chief executive officer Marcus Quierin adds: “There are many behaviours common with investors during volatile and uncertain times, and they can be tempted to focus too much on the present and feel compelled to do something even when sitting tight is the best solution. This means they can fall into the trap of selling low or buying high, for example, and the cost of this on average is around 1.5 per cent to 2 per cent a year over time. Those worried about falling stock markets should remember that they only turn paper losses into real ones when they sell.

“Retail investors should avoid watching the markets day-to-day as this increase anxiety and remain focused on their long-term plans and ignore much of the background noise that can tempt them into making the wrong investment decisions.”

Regular readers of my ‘Round Robin’ e-mails will recognise much of what has been said above.

For graphical proof that sitting tight through this volatile period (so far at least) has been the best strategy, please see the following chart which shows how a selection of our Portfolios have performed since the market bottom on 23rd March.

The sharp rises in just the last week demonstrate how important it is not to miss those good days when they come along, a strategy of trying to time when to come out and when to go back into markets usually doesn’t match just sitting on one’s hands and accepting the long-term nature of this type of investing. As I am very fond of saying, ‘When all looks grim, just put your tin hat on and hide behind the sofa, things will get better in time!’ Or, to quote Churchill, ‘When you are going through hell, keep going!’     

Let’s hope for more good news from the other vaccine trials around the world and keep our fingers crossed for an eventual end to these lockdowns so that businesses can get going again. I fear there may be a few setbacks yet but I am definitely more optimistic looking at the medium term, than I have been for some time.

I look forward to seeing you all on the other side of lockdown but as always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

Second Lockdown

As we enter our second lockdown, despite assurances that this wouldn’t happen, I am reminded of the famous quote from Yogi Berra “It’s déjà vu all over again”. Although Yogi was a baseball player with the New York Yankees, in his spare time he was something of an amateur philosopher, he is also attributed with saying “It’s tough to make predictions, especially about the future!” He could have been thinking about the US election with that one!

The most bitterly contested US election in living memory is still undecided but a result is getting closer. Biden needs 17 Electoral College Votes (ECV) and leads in Arizona (11 ECV) and Nevada (6 electoral votes) so is close to winning. However, Arizona votes are shifting towards Trump and Nevada is a tiny margin. Georgia, Pennsylvania and North Carolina remain undecided and Trump leads at the moment but here the late votes are swinging towards Biden. In North Carolina Trump's lead looks large enough to hold on but in Georgia (16 ECV) and Pennsylvania (20ECV) the Biden vote may overtake Trump.  We may get the vote in Georgia later today but Pennsylvania can go into Friday. Biden leads the popular vote of course but so did Hilary Clinton in 2016.

If Trump loses, he is likely to mount legal challenges in any of these states that go against him.  He has made tweets about the election being stolen and claiming victory in states that have not been decided. Any Legal challenges could take several weeks to resolve.

Given this uncertainty, markets have responded very positively. The losses in US equity markets last week have reversed with the tech sector particularly strong. The failure of the Democrats to take control of the Senate may be a factor in this. It will probably mean Biden's tax plans will be diluted and regulatory threat to the large tech companies may be reduced.  The Tech heavy Nasdaq was up 4% yesterday and futures are pointing higher this morning. With the Senate still in Republican hands, borrowing may not rise as much as feared and Treasuries have rallied reversing much of the pre-election losses.

Even by tomorrow morning we may not have clarity on the vote and legal challenges will take longer. In the meantime, a new stimulus package needs to be passed and the existing houses of congress continue for the rest of the year with Donald Trump remaining in office until 20th January. Some things remain unchanged whoever gets into power, including the fact that both sides want more fiscal stimulus and they both need growth or inflation to help the economy and to reduce the national debt long-term. Interest rates will remain low for a long time. The pandemic will continue and a vaccine may be getting closer to being ready for widespread use. Fiscal and Monetary stimulus will continue for some time, which will continue to support financial markets.

In spite of the lockdown and whatever the outcome of the US election, it is business as usual for us at Clearwater. Adam and Kim will be working from home in accordance with government guidelines but I will be coming into the office each day to ensure there is someone here to answer any queries or concerns you may have throughout this period.

Kim is already writing to clients to either rearrange planned face to face planning meetings or to replace them with a Zoom or Teams call.

I will leave you with one more classic from Yogi Berra, “You should always go to other people’s funerals, otherwise they won’t come to yours!”

I look forward to seeing you all on the other side of lockdown but as always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

How will the outcome of the US election affect markets?

Well we don’t have to long to find out, the election is next Tuesday but with over 65 million Americans having already voted, early indications are that things are not looking good for Mr Trump! However, I seem to recall reading something similar 4 years ago and look how that turned out!

In this article from this morning’s Financial Adviser magazine, Ed Smith, Head of Asset Allocation Research at Rathbones makes some interesting points on what might happen whoever wins.  

“Contrary to popular belief, elections rarely matter for financial markets. 

Looking at 40 years of data, covering equities, the dollar, and bonds, we have found that presidential elections generate a little noise, but rarely any signals. Popular ideas such as ‘Democratic presidents being worse for investment returns’ do not stand up to scrutiny. 

Even sectoral ramifications are often hard to identify. What were the two worst performing sectors during the Obama years? Financials and energy.

The worst under President Trump? Financials and energy. There were and are bigger forces at work, driving the underperformance of those assets, than the vagaries of politicians indulging in rhetorical flourishes. 

Political polarisation means that the Republicans are now right-wing populists and the Democrats are touting more big government, even socialist policies. It is possible – though not certain – that it is different this time. 

Preparing for what comes next 

In mid-September, the betting markets re-evaluated the huge lead they had given Democratic presidential nominee Joe Biden during the summer. 

What were the two worst performing sectors during the Obama years? Financials and energy. The worst under President Trump? Financials and energy

Nominally, Biden still had the edge, but, given the bookies’ track record, the odds suggested it was really too close to call. 

We agreed with this. We do not pretend to be able to predict elections, but we do have the tools to help assess the spread of likely outcomes. “Prepare, don’t predict” is always a good mantra for investors regarding political matters. 

Biden had a huge lead in the national polls, but not in key swing states, where in some cases he led by less than Hilary Clinton did this time four years ago.

Some political science models favoured Biden, but our own econometric model, suggested that Trump still had the edge if – and it is a big if – this election is a referendum on the state of the economy, which is what it usually comes down to. 

But the betting markets have moved again. After the first debate and Trump’s Covid diagnosis, the odds present a greater probability of a Biden victory than ever: a 68 per cent chance. 

The debate is a red herring: post-debate polling failed to predict Trump in 2016, Obama in 2012 and Bush in 2004. 

We agree that Trump’s Covid diagnosis helps Biden, but not to the extent that the bookies suggest.. 

Analysis of myriad opinion surveys suggests that Biden’s chances are maximized if he keeps voter attention away from the economy and on the disease. 

Trump’s economic track record is too strong (whether US economic strength had much to do with his policies or not is irrelevant). 

Typically, more Americans approve of his handling of the economy than approve of him as their president. 

But the US’s Covid second wave (and possibly now its third) impacted a disproportionate number of counties in swing states that Trump won last time.

Moreover, only 40 per cent of independent voters, who account for about 40 per cent of the electorate, approve of the way Trump has responded to the health crisis. 

Fear of the unknown

Markets believe the worst outcome is no outcome at all. 

November VIX futures – the price of volatility protection – are notably elevated, more so than usual for an election month. 

A recent survey of 1377 institutional investors by Citi found that 45 per cent expect US equities to fall by more than 10 per cent if there’s no result by Thanksgiving (26 November), with another 30 per cent expecting markets to fall by a number in the 5-10 per cent.  

Why are investors more fearful of this scenario than anything else? Some investors believe the hyperbolic articles which envisage Trump ordering the army to seize ballot papers, undermining the rule of law and democracy which have an important relationship with economic development and depth of capital markets. 

But this may be a misguided fear. States run the election, not Washington, and the concession of the incumbent is not required for power to transition. 

We think investors should be more fearful of a stimulus stalemate.  

While the result is still contested, additional fiscal stimulus is unlikely to happen. 

This would be risky even in the absence of any other bad news, but it could be very problematic if the economy or the virus took a turn for the worse during that time. 

While a delayed stimulus increases the risk of harming the economy permanently, its long-term impact that will be minimal.  

Moreover, while the fiscal backstop may be removed temporarily, the monetary backstop of very low interest rates and quantitative easing would remain operational, and supportive of stock markets and the economy.  

A very long delay to the result is unlikely, but some judicial challenges could happen, delaying the result for a short period.

And while we don’t think it is a useful comparison, for reference, the S&P 500 fell by 4 per cent between election day 2000 and the 12 December, when the Supreme Court intervened to rule in Bush’s favour.

It underperformed the MSCI World Index by 0.8 per cent. But this decline coincided with the start of the dotcom market crash, so will not be a precise example of what may happen this time. 

A Biden bounce

The second most adverse scenario for markets according to the Citi survey is a Democratic clean sweep – Biden in the White House, Democrats controlling both chambers in Congress. Some 23 per cent of respondents expect US equities to fall by more than 10 per cent, with another 25 per cent expecting a 5-10 per cent fall. 

Of course, there are more investors who think Biden will win than there are those who think Trump will win. According to a Deutsche Bank poll from September, 40 per cent of investors thought Trump was either extremely or slightly likely to win, compared to 46 per cent for Biden. 

The Citi poll gave similar results – 41 per cent versus 46 per cent - as did a Goldman Sachs poll. We expect this has risen in October, and so some of this risk will be in the price of financial assets already.

What is more, there has been no correlation between changes in Biden’s polling numbers and US equity market performance.

The first full week in October saw a big increase in Biden’s election odds/polling and a rising S&P 500 and Nasdaq. 

Perhaps that is because past elections have had limited impact on the broad market.

Or because history is on the Democrat’s side in terms of the economy. Pre-eminent economists Nouriel Rubini and Alberto Alesina have shown that the Democrats tend to preside over faster growth, lower unemployment, and stronger stock markets than Republican presidents.

Recessions are almost invariably caused by imbalances built up by Republicans loosening regulations. Nothing destroys stock returns like a financial crisis. 

But Biden’s agenda is more left-leaning than that of most Democratic presidents. 

Perhaps the lack of correlation is because investors do not interpret Biden’s strengthening polling numbers as a proxy for the likelihood of the Democrats retaking the Senate. 

It is easier for Biden to take the White House than it is for the Democrats to retake the Senate, due to the seats up for grabs this year (100 Senators serve six-year terms, with a third of seats up for election every two years). Assuming the Democrats lose Alabama (a very red state), they need to win back four other states. 

However, Democratic challengers have started to poll increasingly well since early September. 

Arizona and Colorado look highly likely to flip. North Carolina and Maine are leaning that way too, and it’s really close in Iowa and Montana. The election forecaster, ‘FiveThirtyEight’ believes the Democrats are “slightly favoured” to win the Senate, a significant change from mid-September when their simulations suggested it was too close to call. 

Again, despite these large moves, US equity markets appeared unperturbed. 

It is entirely possible, therefore, that the institutional investors surveyed are not representative, and that equity markets will not fall sharply on a Democratic clean sweep.

After all, what has been driving markets this year?

1. The hope for a timely, effective vaccine;

2. Supportive fiscal policy;

3. Supportive monetary policy;

4. A levelling-off of previously escalating Sino-US trade tensions.

Are any of those four pillars likely to be undermined by the clean sweep? 

A President is unlikely to alter the outlook for a vaccine. Fiscal policy is likely to stay very loose under both Trump and Biden - its distribution will change materially, but not its scale. 

Historically, a presidential candidate committing to very loose fiscal policy would have caused markets to expect tighter monetary policy, that is, higher interest rates as the central bank decides the extra government spending will create higher inflation, so higher rates are required to counter this threat.  

But this time the central bank, the US Federal Reserve has committed to holding interest rates near zero until the end of 2023, even if inflation rises above 2 per cent. 

As such, is it as simple as the outcome with the most stimulatory fiscal policy is the most positive for markets? 

The risk of intolerably high inflation is a little greater under Biden, but over the next couple of years we expect both structural and cyclical forces to be stronger than the effect of shorter-term factors. 

Structural changes in society such as ageing populations, high debt levels and greater adoption of technology are all long-term trends that create disinflation. Despite the stimulus that was in the economy in September, inflation was very weak, which justifies our position.  

As good as it gets? 

An outcome where Biden wins the presidency, but not the senate, may be the best outcome for markets. 

Institutional investor surveys suggest this outcome is also likely to cause markets to fall, although by a smaller amount than if the Democrats win big or the result is contested. 

Contrarily, we think there is a strong argument to be made for this being a very market-friendly outcome over the medium-term. 

Little changes on the fiscal or monetary policy fronts, while there is no chance that Biden could get any large increases in corporation tax through Congress, or any of his most redistributional agenda items that markets fear the most. 

But foreign and trade policy uncertainty will ease significantly. The substance of Biden’s trade policy is similar to Trump’s, at least on China, but the style will change. 

This change may benefit non-US equity markets more than US markets. 

From a global perspective this election is about whether global policy uncertainty will continue its dramatic ascent in recent years.

Huge increases in uncertainty, particularly around what American protectionism/unilateralism means for foreign export-oriented economies, have augmented US equity outperformance and the US dollar bull market. 

An approach that means America is more conscious of its impact on the rest of the world, would likely lift all boats.  

That is because the US is a more insular economy, with a lower trade-to-GDP ratio, its stock market is less cyclical than many others and less sensitive to the global trade cycle, and the dollar is a safe haven currency 

If Trump is elected, uncertainty will likely spike again – hamstrung by a split Congress he would focus more on trade, where he does not need Congressional approval, just as he did after the midterms. This would support US equities, relative to the rest of the world. 

A Biden win is not a foregone conclusion but whatever the result, history would suggest we will not see huge market swings on the outcome.”

I thought this article was extremely interesting and I would echo Ed Smith’s comment that markets have probably already priced in (to a certain extent) the most likely outcome because that’s the way efficient markets work.   

As always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

You can’t tax your way out of this - Chancellor Sunak will need a Plan B

I have felt for some time that tax rises alone are unlikely to be sufficient to repay the enormous sums the government has borrowed (so far) during the coronavirus pandemic and it seems that Steve Russell, Investment Director of Ruffer Investments, agrees with me. His post on the Ruffer website from this morning follows:

“16 October 2020

The coronavirus pandemic has hit public finances like a war. Across the world governments have scrambled to offset the economic and social impact of the virus. Huge, and necessary, rises in public spending have pushed government deficits to levels not seen since the two world wars of the twentieth century.

The numbers are enormous: UK government debt now tops £2 trillion1 whilst the US owes an eyewatering $26 trillion.2 The picture is similar across Europe with many other countries also seeing debt/GDP ratios rising to over 100%.3

We think such debt levels are simply too big to be repaid through tax rises. In the UK, increasing everyone’s income tax by 1% would only raise an estimated £5-6 billion.4 Similarly, a 1% rise in VAT would raise about £7 billion.5 Neither of these would make any noticeable dent in this mountain of debt, even doing both would still take 150 years to pay down today’s debts. No wonder Rishi Sunak cancelled his autumn budget – he’s going to need a Plan B.

Fortunately, zero interest rates mean there is no immediate need to repay the debt. But eventually it will need to be tackled. If raising tax won’t do the job, how can governments get deficits down to manageable levels?

Perhaps history can help us. After the first world war Britain opted for austerity and government spending fell by 75%.6 Unemployment soared and the country suffered a deep depression. The medicine worked, but it almost killed the patient. This is simply politically unacceptable in today’s world.

The second world war may hold more clues for today’s policy makers. A combination of rapid post-war economic growth plus a healthy dose of inflation saw deficits fall rapidly. In the 30 years immediately after WWII nominal growth averaged 8.8% – made up of 2.3% real GDP growth and 6.5% inflation.7

This time, however, such levels of economic growth are likely to be harder to achieve. There is no post-war rebuilding boom to come, no peace ‘dividend’. Instead it looks like inflation, not growth, austerity or taxation, will have to do the heavy lifting.

That said, taxes may well still rise. The chancellor may have higher rate income tax in his sights, or capital gains, or even a wealth tax, but this will be for political reasons and will likely be limited in impact.

So, could it be that inflation, not tax, poses the greatest risk to savers today? Perhaps this will turn out to be Rishi Sunak’s Plan B. At Ruffer we think history shows that this is a risk worth protecting against, so over 40% of our portfolios consist of inflation-linked bonds and gold. After all, as Ben Bernanke told the National Economists Club back in November 2002: ‘government has a technology, called a printing press…’

1. Office for National Statistics, Public Sector Finances UK July 2020

2. US Treasury, Debt to the Penny, 30 September 2020 Fiscal Data

3. Goldman Sachs, 24 March 2020

4. Institute for Fiscal Studies, September 2020

5. Ibid

6. The National Archives

7. OBR Office for Budget Responsibility, Post-WWII debt reduction, 11 September 2017”

As always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.

Have an enjoyable weekend.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

Coronavirus: The end is in sight?

The above heading is the title of a White Paper I have just received from 7IM Investment Managers, it is a very optimistic view of what might come next in the year of Coronavirus. The paper was published on 26th August and with cases rising rapidly in the UK and across Europe, there must already be some doubt about its cheery forecasts – the question mark in the heading is mine!

The White Paper runs to 19 pages, which means I am unable to reproduce it here and rather than paraphrasing it, if you would like a copy please let me know and I will be very happy to send it on to you.

Regardless of your own personal view on whether things are likely to get better or worse from here, it does make for an interesting read.

As always, if you have any questions about any finance related matter, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

The bubble may burst, but I’ll keep on investing!

The following is Ian Cowie’s column from last weekend’s Money section of the Sunday Times. Ian writes as a long-term personal investor whose insights and experiences I always find thought-provoking. I have highlighted a couple of the sections you might find particularly interesting:

“Next month will mark the 300th anniversary of one of the biggest ever stock market shocks, the bursting of the South Sea Bubble. Back then, investors bought into businesses with little or no understanding of how returns would be generated, and soaring share prices became detached from reality. Sound familiar?

Last week Japan, the third-largest economy in the world, reported that coronavirus had caused its gross domestic product to shrink sharply, following similar announcements from the US and Britain. Yet many shares — plus gold and government bonds — remain priced at or near record peaks.

So, this long-term investor asked seasoned experts, who have survived several booms and busts, how to spot a bubble before it bursts, and whether they can see any now. These are sensitive topics that many financial professionals would rather not talk about.

Terry Smith, one of the few “star” fund managers who has not fallen to earth, refused several requests for comment. What a difference from the last time we met, when I could hardly get a word in edgewise. James Anderson, fund manager of the only investment trust that is big enough to feature in the FTSE 100, was also uncharacteristically silent. Scottish Mortgage’s biggest holding is the electric car-maker Tesla, which has a stock market value of $308 billion (£237 billion), bigger than Toyota, Volkswagen and Honda combined, although Tesla has a fraction of their sales and only began to make a profit this year.

Fortunately, two senior fund managers were willing to break the taboo and talk. They are Nick Train, the manager of the £1.86 billion Finsbury Growth & Income, the top-performing UK equity income investment trust over the past five and ten-year periods, and Paul Niven, manager of the £3.8 billion global fund F&C, which has survived for more than 150 years.

Cutting straight to the chase — and my most valuable holding — Train told me: “Look at the stock market value of Apple, which stands today at £1.5 trillion [at close of play on Friday it had a market capitalisation of $2.13 trillion].

“As a UK Equity investor I can’t help comparing that to the current value of the FTSE all-share index, which stands at about £1.9 trillion. Can one American technology company really be worth more than the entire British stock market?

“Is that mad? Is Apple a bubble? Or is the UK stock market just very undervalued?”

His answer is based on deep and wide analysis, citing Charles Mackay’s 1841 classic study of financial booms and busts, Extraordinary Popular Delusions and the Madness of Crowds. It is also surprising.

“When you consider episodes that look as though they may be bubbles, it becomes clear that many are rational responses by investors to the promise of new technology and new industries,” Train said. “Yes, there are excesses. But without the gains from new technology and new industries, stock market returns over the decades would be lamentable. A big explanation for the disappointing performance of the UK stock market during the last five years is precisely that we have not produced an Apple or Amazon of our own.”

Turning to the question of timing and perhaps cashing out before prices fall, Niven pointed out: “Even experts find it hard to time the end of a stock market bubble.

“The chairman of the US Federal Reserve, Alan Greenspan, worried about ‘irrational exuberance’ in 1996, only to see the American market double before it peaked at the turn of the millennium in 2000.”

Looking further back, imperial monopolist and slave trader the South Sea Company saw its stock price soar by nearly ten times in the year before its bubble burst in September 1720. Fear of missing out had prompted many to invest, including Sir Isaac Newton, who noted ruefully: “I can calculate the movement of the stars, but not the madness of men.”

Even a blowout can present opportunities for long-term investors. “F&C Investment trust first purchased Amazon, our largest listed holding, in 2006,” Niven said. “The end of the dotcom bubble had brought these shares back to earth, but great companies can entrench their competitive position during a recession.”

Historic low interest rates may mean that present valuations are not as stretched as they look. Put another way, quantitative easing — or central banks pumping money into markets — causes the real value, or purchasing power of cash to fall while it pushes up the market price of investments.

Meanwhile, assets that produce low or no income, such as gold and many government bonds, are not as safe as they look. Bullion and bonds now invert their traditional promise and offer a return-free risk.

By contrast, funds and shares that confer ownership in businesses we expect to trade long after we are gone — and which pay us to be patient — look like better bets over the long term. Unfortunately, both will continue to shock in the short term.

The American Federal Reserve is the biggest central bank in the world and, as a general rule, it doesn’t pay to fight the Fed. Along with others, including the Bank of England, the Fed has indicated that it will do whatever it takes to prevent this recession turning into a repeat of the Great Depression.

City cynics say that bears (pessimists), sound clever but bulls (optimists), make money. So, apart from retaining a small amount of cash to take advantage of any opportunities that arise, I intend to remain almost fully invested.

I missed the rise of Apple but, it’s not too late for any of us

Here are three words of comfort for anyone who fears that they might have left it too late to participate in the technology boom by investing in the digital giant Apple: I did too.

For more than quarter of a century after I bought my first computer — since you ask, a black and white Apple Macintosh Classic in 1990 — I failed to buy the shares. As the price continued to climb, I became convinced that I had missed my chance.

Then I had a moment of epiphany when I realised there was no point worrying about the past because we can only invest in the present for the future. That was when I stopped dithering and bought Apple shares at $95 each in February 2016.

Since then, the stock has soared to trade at $497 last week and become the most valuable holding in my “forever” fund.

Despite two bouts of profit-taking, both involving five-figure sales, Apple accounts for slightly more than 7 per cent of the total value of my portfolio.

It’s only fair to add that when I reported my investment back then, there were several clever Dicks who claimed that I had left it too late and who predicted imminent doom. Critics have been calling the top of this bull run, or period of rising prices all the way up.

By contrast, I argued that the genius of Apple is to produce digital equipment for folk who are not that keen on new technology. More recently, I pointed out how the switch to services and wearables — including iTunes and AirPods — has enabled the company to continue growing, even as iPhone sales slow.

Most importantly for investors, Apple demonstrates why we must look forward, not backwards. At least until someone invents a Tardis or time machine we cannot trade at yesterday’s price.”

Email ian.cowie@sunday-times.co.uk and follow him on Twitter at @iancowie

As a footnote, at a Financial Planning Conference I once listened to an economist confidently predict a crash in the US market, only for a wag in the front row to shout, “You’ve said that at each of the last 6 of these conferences and it hasn’t happened yet, if I had listened to you 6 years ago, my clients would have missed out on a fortune!” The Cassandras of the world with their prophecies of doom and disaster will be right from time to time (much like a stopped clock is right twice a day) but in the interim, serious money is made by those prepared to stay invested through the inevitable ups and downs.  

I hope you have found this communication of interest but if you have any questions, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

Was Lockdown a Catastrophic Policy Error?

The following article, which is an interview with Barry Norris of Argonaut Investments, is a controversial but very interesting read.

Personally, I don’t think we will truly know the answer to this question for some years to come but is easy to imagine how governments around the globe the world might have felt pressured into taking extreme action through fear of recriminations and enormous political damage if they were not seen to do enough.  

Interview with Barry Norris of Argonaut

The UK Government's decision to implement a lockdown was one of the "biggest policy errors since 1914", according to Argonaut's Barry Norris, who believes "thoughtful debate" on the Government's response to the pandemic has been "shut down" and that "following expert opinion blindly" is "normally the road to ruin".

The manager, who runs the FP Argonaut Absolute Return, European Alpha and European Income Opportunities funds, believes the UK Government has been "talking to the wrong experts" in terms of how best to deal with the pandemic, and believes a Sweden-style approach would have been more beneficial for the country from both an economic and societal perspective.

As such, he has taken out shorts on "essentially all vaccine developers", although he is still cautious on retail and leisure stocks given the potential long-term impact lockdown will have on their revenues and business models. 

"The economic data as a result of this crisis makes 2008 seem like a small blip, so for a fund manager not to have a view on lockdown and the policy response to Covid would mean we are not doing our jobs," he reasoned.

"Somebody asked me the other day whether I was just an armchair epidemiologist. The answer to that is I am an armchair everything, because I have never worked in any of the industries I have invested in but that doesn't stop me from gathering what most people would regard as an informed opinion on those industries.

"Also, having been a fund manager and listened to lots of industry analysts, I can tell you that following expert opinion blindly is normally the road to ruin."

In Norris's personal view, it became "bizarre" how many people "seemed to enjoy lockdown" and therefore "willed" Sweden - whose prime minister Stefan Löfven decided not to impose a lockdown - to fail.

According to statistics from the European Centre for Disease Prevention and Control dated 18 August 2020, Sweden has had 85,045 recorded cases, 5,787 deaths and 4,033 new cases of Covid-19 in the last 14 days overall relative to a population of 10.2 million.

In the UK, there have been 319,197 recorded cases, 41,369 deaths and 13,574 new reported cases over the past fortnight, relative to a population of 66.7 million.

This means that 0.057% (to the nearest three decimal points) of Sweden's population has died from coronavirus, while 0.062% of the UK's population has died as a result of Covid-19.

However, it should be noted that each country has varying measures in terms of how many tests have been administered and how their death rates have been accumulated and calculated.

Population density (the UK has 275 people per square kilometre and Sweden has 25.4 people per square kilometre) and demographics (the UK population's average age is 40.5 and Sweden's average age is 41.2) must also be taken into account, alongside numerous other variables including socioeconomic data and the underlying health of both populations before the crisis.

Norris believes that a large percentage of Sweden's deaths occurred in care homes after people who became infected with Covid-19 were moved there, and subsequently passed the disease onto people with weaker-than-average immune systems.

"If you look at the number of deaths in Sweden aside from care homes the number is pretty similar to a normal flu season," he argued.

"Sweden has probably reached a kind of herd immunity already, so therefore society in Sweden can return to normal.

"Economic growth in Sweden contracted by 8% in Q2 which is obviously still a disaster, but that is predominantly because the rest of the world shut down their economies.

"The American economy contracted by 33% and the UK economy 25% because of lockdown policy."

He added: "There is a trade-off between the economic devastation and the public health benefit, but I don't believe there was any public health benefit.”

"In fact, one of the problems of lockdown was that health services became almost a Covid-only service."

Norris believes the UK Government initially sought to follow Sweden's lead, but Prime Minister Boris Johnson "bottled it" for fear of facing tough allegations from mainstream media.

"Boris was told, if he didn't lock down, journalists will ask him on national television to accept responsibility and apologise to the families of those who have died as a result of Covid-19, because the rhetoric would have been that is was his fault for not locking down," the manager continued.

"Now, they cannot admit that they have made a mistake because it is about saving face. The entire world has been hoodwinked by the initial diagnosis of what Covid-19 was and its severity, and that is why I think it is a fraud.

"I have thought long and hard about whether to use the word 'fraud', but in our lifetime, it has been the most significant negative event for the global economy since WWI, and the biggest policy error since 1914 when the Austrian Archduke was assassinated in Sarajevo."

Despite believing lockdown was an unnecessary measure, Norris believes its impact will be felt across economies over the long term, and in some instances, permanently.

"If you accept my version of the truth, it might be tempting to buy every single airline and cruise ship operator because lockdown has happened once and it won't ever happen again," he said.

"However, that doesn't mean that even if the population's consensus on Covid changes overnight, the government will suddenly throw its hands up and admit to making a mess of this.

"They could even end up doubling down on their policy error. They have potentially become prisoners of their own propaganda.

"You have seen this through random quarantines and the bizarre introduction of face masks. There will probably be future policy error as well."

As such, the manager has shorts on severely-impacted stocks such as Cineworld, as well as holdings in the high-street retail and travel & leisure.

"Industries such as shopping malls are not going to survive lockdown, period," he said.

"With travel stocks, they will spend a whole year without revenues so these will need to be recapitalised, thereby diluting the shareholders through new capital."

"I also think there has been a permanent cultural shift in terms of working from home, which means office properties will continue to struggle.

"It also means we are very bullish on UK housebuilders though, given people will be spending more time in their homes."

That said, Norris holds long exposure to "one or two" airlines which, while they may not do well "over the next few months", have the propensity to be "long-term winners".

Elsewhere, he is short "all vaccine manufacturers" as he said the companies involved have "never brought a drug to market before", and that when a vaccine is approved for widespread use, it will work less efficiently than many people expect it to.

"The mortality rate from patients hospitalised from Covid has fallen significantly and the way they are treating patients in hospitals is through cheap drugs, such as anti-inflammatories or blood thinners - these drugs don't cost a lot of money," the manager argued.

"You have to wonder about the lobbying element among pharmaceutical companies, which obviously do not want solutions for Covid-19 to be cheap, generic drugs, because that will mean a struggle in terms of profit margins.

"I sound like a big conspiracy theorist but I don't categorise myself as that - this policy move and the inability of the government to admit what has happened - it really is that extreme."

I did say it was controversial and as to whether Norris is right, only time will tell.

I hope you have found this communication of interest but if you have any questions, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

The Impact of Government Borrowing on Investments

I am increasingly being asked about how the governments enormous stimulus packages in response to the coronavirus pandemic can be paid for and what impact this might have on client investments. The following article (it’s a little long but well worth the read) by David Thorpe, special projects editor of Financial Adviser and FTAdviser, goes someway to answering these questions. The article is aimed at Financial Advisers but it is reasonably accessible.

“The response of governments across the world to the pandemic-induced collapse in economic activity has been to inject hundreds of billions of pounds of borrowed money into the system in an effort to plug the gaping holes wrought upon the economy by the virus.

Gilles Moec, group chief economist at AXA says a particular feature of this policy response is the extent to which policy makers and commentators around the world accepted the need for governments to borrow money and spend it at this time. Mr Moec adds that, while there are a range of potential consequences for advisers and their clients from the bigger debt pile, it would be wrong to focus in the short-term on repaying the debt.

He said that one of the negatives that typically arises from higher levels of government borrowing is much higher inflation in the short term. This can happen either because too much cash is pumped into the economy, so demand rises faster than supply, or because the extra currency entering the system leads to a fall in the value of the currency, making imports more expensive. The reduction in economic demand has been so severe that inflation will remain low for an extended Period.

Were either of these scenarios to play out in the UK, the resultant inflation would be magnified by the additional costs businesses face as a result of the pandemic, for example, from spending money on extra cleaning of premises, or buying masks. But Mr Moec does not believe inflation is something that advisers will need to worry about in the near term, as he believes the reduction in economic demand has been so severe that inflation will remain low

Government debt never really needs to be paid back; instead it needs to be refinanced, that is, as the bonds mature and investors get their capital back, the capital is repaid with newly issued bonds.

The ten-year bonds of the UK government currently have an interest rate of 0.1 per cent. So, while it is not the case that the UK government will in ten years have to find all of the money to repay bondholders then, the uncertainty comes from what interest rate the government will have to pay on the debt in ten years, if it is much higher than the current rate, that will create future funding problems. But, Mr Moec does not believe inflation is something that advisers will need to worry about in the near term, as he believes the reduction in economic demand has been so severe that inflation will remain low for an extended period.

He draws a parallel with the world in the years immediately following the second world war, when governments rapidly increased spending, but inflation did not rise to unhealthy levels in those years, as the extra spending was replacing demand lost in the war, rather than creating an excess of demand.

Mr Moec says this shows: “There is no need for austerity to be used this time to get the deficit down.”

Neil Williams, senior economic adviser at Hermes, says the debt level will not be a problem for the wider economy as long as central banks are happy to let inflation rise.

The only remit of the Bank of England in terms of economic management is to achieve inflation at or near 2 per cent annually; if this was happening, the central bank may stop buying government bonds, and make it harder for governments to refinance.

He says he does not expect central banks to act in this way, as inflation was considerably below target prior to Covid; he anticipates policymakers will tolerate it being above target for an extended period.

Stephen Bell, managing director of Global Macro at BMO Asset Management, says that he does not believe inflation will be a problem in the near term, because the unemployment rate may be relatively high for a prolonged period of time. This is deflationary in an economy as it means individuals have less money to spend.

Bill Dinning, chief investment officer at Waverton, is less sanguine. He says: “There will have to be a reckoning, from all of this borrowing, it may be that inflation is higher and clients have to deal with that, or it may be something else.”

The nature of the recession

While the definition of a recession as two consecutive quarters of negative growth is universal, there are a multitude of different types of recessions.

The downturn caused by Covid-19 is what economists call an exogenous shock, that is, caused by an event outside of the financial system.

Such recessions tend to be very sudden, very deep, and over very quickly. They end relatively quickly because if the shock is from outside the system, as the shock subsides, the system is intact and activity can return to previous levels.

This is the thinking behind those who believe the UK economy will recover in a V shape. But Fahad Kamal, strategist at BNY Mellon, says this is not a typical exogenous shock-induced recession, because the impact of the pandemic may have changed long-term societal trends. He says those factors, such as remote working, will lead to “permanent“ changes in the structure of the economy.

Exogenous shocks do not typically leave permanent changes, but Mr Kamal says the combination of the Covid crisis and the changes to society are creating “lost growth” which will not be recovered by the economy.

The multiplier effect

The rationale for government’s increasing spending in a downturn was first created by the UK economist John Maynard Keynes, who described a “multiplier effect”. This is the idea that, if the government stimulus is spent properly, it can generate more activity and wealth in the economy than the cost of the original debt.

Some economic activities have a larger, and faster acting, multiplier than others. For example, a pound spent by the government on a construction project tends to move quickly through the economy as such a project employs many people in different trades and requires the purchase of raw materials.

If the multiplier in an economy works, then the pace and rate of GDP growth should increase rapidly.

Using borrowed money to increase the salaries of already relatively highly paid people may not have the same effect, as the extra salary may not be spent quickly.

But Hugh Gimber, chief market strategist at JP Morgan Asset Management says that despite the vast sums pumped into the economy, investors should not expect the multiplier to be high in the UK.

Mr Gimber says: “While a lot of money has been pumped into the economy, it has not delivered the traditional benefits of a stimulus. This is because while the money went in, we were told to not go out, we couldn’t spend it, so it didn’t multiply. I also think there are factors in the UK such as the ageing population that were already present and not really conducive to growth.

Mr Dinning says the borrowing and spending now may actually reduce the multiplier of future government spending. He says: “The cash that has been spent now is to sort out an emergency. It is absolutely the right thing to do, but it also is likely to mean that there is less ability to borrow in future, so there would be less cash for spending on long-term projects in areas such as infrastructure that contribute positively to economic growth.

"So it may be the borrowing now, lowers the longer-term growth rate in a way that is almost permanent.”

Mr Williams says other policy decisions taken over the past decade probably mean any multiplier effect will be much slower. He said the policy of quantitative easing, whereby the Bank of England buys government debt and other bonds helps to keep borrowing costs low, but also reduces the multiplier achieved on that debt. This is because the bond buying programme causes asset prices to rise.

So, for example, in the decade after the global financial crisis, house prices in the UK rose much more quickly than did incomes. This meant people seeking to get onto the housing ladder had to save more of their income and for longer to do this, and that reduces the amount they can spend in the economy.

With central banks continuing to buy bonds as part of the Covid response, Mr Williams says the rise in asset prices is likely to continue, meaning those that have to save to buy assets will need to save more.

In this way, “even if the policy succeeds in getting money into people’s pockets, which is not something that happened after the global financial crisis, higher asset prices will have an impact on spending levels and growth.”

Portfolio impact

Gero Jung, chief economist at Mirabaud says it is a central tenet of investment theory that if interest rates are low, then equities will rise in value.

This is because many equities are priced relative to the return available on cash on bonds. Low bond yields and low interest rates therefore make equities relatively more attractive. He says it is unlikely that interest rates will rise for many years into the future, and this will be supportive of equities.

Mr Gimber says the yield on government bonds is now so low that they are an unattractive income investment. He says: “The rationale historically for owning government bonds in a portfolio is that they are a diversifier and they pay an income. "But now they don’t pay an income and the diversification effects may not be as strong as in the past. I think real assets are more interesting, as they offer income and can offer inflation protection.”

Mr Moec says in the short-term the profits achieved by companies will be lower, as they deal with the higher costs of restrictions, but will not be able to pass the costs onto consumers due to the pressure on wages and higher unemployment. For this reason, he believes that investors will just have to accept lower equity returns for the foreseeable future.

Mr Bell agrees that returns to equity investors will be lower in the years ahead, but he believes the returns will be more attractive than those available from other asset classes.”

I hope you have found this information of interest but if you have any questions, please do not hesitate to contact me at any time.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner

Virtual Client Meetings

Little by little the UK appears to be returning to normal but with some very obvious differences, masks on when travelling and shopping, the need to book an appointment to have a beer at the pub and waiters wearing Darth Vader PPE to bring food to your table in restaurants. With infections falling in the UK but rising elsewhere in the world, it does beg the question, how long will these changes be around for? Will we, like a number of Asian countries, find ourselves wearing masks for years to come for example and will everyone ever actually return to head offices in London?

We at Clearwater are also trying to adopt a ‘business as usual’ approach and that now extends to offering meetings at our offices in Holmer Green, at the client’s own risk of course. We have cleaning materials, including anti-bacterial sprays and we are confident that we can observe an appropriate degree of social distancing whilst you are here.

If you are not yet comfortable to visit us in person, which I would quite understand, we are very happy to offer you a ‘Virtual Meeting’ using Zoom or Microsoft Teams. Our new high-speed internet makes Virtual meetings a very good substitute for the real thing. We have conducted a number of these meetings now and we have received some positive feedback from the clients who have been through the process. The only piece of technology you will need is a computer or iPad with a camera and audio capability (I guess you could do it on a phone but it would all be rather small), we can provide instructions on the software prior to the meeting, if you have not done this sort of thing before, it really is very straightforward.

The technology enables me to share my computer screen, so I can beam all of the charts I would normally go through on my touch screen onto your own PC or Laptop, this usually makes for a very productive session.

If you would like to book a meeting for either a face to face or virtual get together, please do get in touch and we will be happy to arrange something. If we don’t hear from you, Kim will restart her diary and invite you to Planning Meetings as they fall due, you will then be able to decide which type of meeting you prefer.

If you have any questions about this e-mail or indeed on any finance related matter, please do not hesitate to contact me.

With best regards,

Yours sincerely

Graham Ponting CFP Chartered MCSI

Managing Partner