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Artemis: Our view on regulatory changes in China

Please see below for one of Artemis’ latest articles received by us this morning 12/08/2021:

Regulatory changes in China continue to cause uncertainty. Raheel Altaf, co-manager of Artemis’ global emerging markets strategy, explains how the investment process has helped to provide downside protection. He shares his outlook and sets out why he believes exceptional value can still be found.

Over the past 12 months there have been a series of regulatory changes in China covering a range of industries.

Why is China doing this?

The main reason for this lies in the government’s determination to develop China into a modern socialist economy. The objectives of common prosperity, green development and independence in key technologies and industries are at the heart of their long-term agenda and are designed to achieve the nation’s rejuvenation by the middle of this century. The developments have mainly taken place in ‘new economy’ sectors, such as internet platforms and e-commerce. These have grown rapidly, in part because of lax regulations. The situation is changing now. The catch-up in regulation aims to address loopholes to ensure fair competition and sustainable growth.

Effects felt across multiple industries

These developments have led to sharp falls in share prices of former strong performers. For example, in February, anti-monopolistic laws targeting internet platforms were announced. This put pressure on some of China’s ‘mega-cap’ internet stocks, in particular Tencent and Alibaba. In July, China ordered education firms to go non-profit and banned foreign ownership. Shares of education stocks such as Tal Education and New Oriental Education fell around 70% as a result. More recently there have been reports that regulation on gaming may be increased, leading to jitters in that sector.

Our approach

We have been concerned for several years that the risks in popular (and often unprofitable) new economy stocks in China were not well reflected in their share prices, which had reached excessive levels. So we have avoided investing in these companies, which has at times been costly for our fund’s performance.

Is now the time to buy them?

We would argue that valuations have certainly moderated but fundamentals are deteriorating. Our proprietary screening tool SmartGARP has been indicating to us that the growth in ‘value per share’ (a combination of earnings, cash flows, dividends, operating profits and net assets) in these companies has been slowing. This is the result of new regulations, but also other competitive pressures. These risks can derail high-growth stocks at the end of their cycle. Share prices have corrected, but with the fundamental outlook heading downwards these stocks appear expensive and have the potential for further weakness.

Analysts continue to downgrade their profit forecasts in these mega-cap Chinese internet companies. With many Asian companies expected to report their Q2 earnings in August, we remain watchful for how the current environment has affected companies’ profits.

We have been commenting for some time on the stretched dispersion in valuations between low and high value stocks. The last six months have seen this start to reverse in many global markets.

In China, the valuation spreads reached extreme levels and the reversal only started at the end of January. There is therefore some way to go to catch up. Should China follow the same path as others, we expect a number of our holdings to see significant benefits.

Outlook

While continuing to avoid the mega cap internet stocks, we are still seeing attractive value in other less popular areas of the market, where the risk reward is highly favourable. Chinese banks (an overweight), as an example, have been a relatively safe haven recently. We expect markets to remain volatile, but remain confident that the favourable value per share of our holdings relative to the market is likely to be rewarded over time with better fund performance.

The fund’s value bias remains substantial. The Price/Book ratio of the fund is 0.8 and it offers a forward P/E of 6.3 vs 12.7 for the index (50% discount). The opportunity, in our eyes, remains an exceptional one.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date.

Keep safe and well

Paul Green DipFA

12/08/2021

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Are Cash ISA savers holding too much cash?

Please see below for one of AJ Bell Youinvest’s latest Investment Insight articles, received by us yesterday 21/03/2021:

New consumer research* by Opinium for AJ Bell shows Cash ISA savers are holding high levels of cash, and aren’t switching accounts looking for better rates, partly because they think they’re getting more interest than they probably are.

We know that since the start of the pandemic, many savers have been all cashed up with nowhere to go. But our research shows that cash hoarding isn’t just a recent phenomenon, it’s been happening for some time, and reflects a natural aversion to taking risk with money that has been hard-earned.

It’s definitely prudent to build up a cash buffer to deal with any unexpected costs, particularly in uncertain times. But Cash ISA savers may well be doing themselves a disservice by holding too much money in cash, opening themselves up to inflation risk, and missing out on the potentially higher returns available from investments. As stock market investors need to avoid irrational exuberance, so cash savers should be wary of excessive prudence.

Over the last ten years, the average Cash ISA has turned £10,000 into £9,770 after factoring in inflation, while in contrast, an investment in the global stock market has turned £10,000 into £20,760 in real terms.** Looking at returns from 1899, Barclays found that over ten years, UK equities have beaten cash 91% of the time. Given that today cash interest rates are at record lows, it would have to be an extremely anomalous decade for the next ten years to buck that trend.

Cash ISA savers aren’t shopping around for the best rate a great deal either. Much of their apathy can be attributed to ultra-low interest rates, but part of it may simply be that they haven’t checked the rate they’re getting. Our survey found that on average Cash ISA holders hadn’t reviewed their rate for two and a half years, over which time the average Cash ISA interest rate has more than halved, from 0.9% to 0.4%.

Not all rates move in step though, and individual savers can suffer as a result of their provider slashing rates more aggressively than the rest of the market, hence why it continues to make sense to shop around. For instance, last November, savers in NS&I’s Direct ISA saw their interest rate cut from 0.9% to 0.1%, while the best rates on the market are around 0.5%.

Even the top rates on offer aren’t exactly going to set pulses racing, but switching can mean hundreds of pounds extra for those with large amounts held in Cash ISAs. At the very least Cash ISA savers should find out what rate they’re getting right now, to make an informed decision on whether it’s worth moving on.

All cashed up and nowhere to go

Our survey shows Cash ISA savers reported holding on average £27,727 in their accounts. That’s enough to pay for 11 months of household expenses, which come in at £2,538 on average according to the ONS.*** When you consider that many households will contain two Cash ISA holders, and may also own other cash products like savings accounts and Premium Bonds, that suggests that savers have enough built up to deal with any emergency spending, and then some. On top of that, 6 out of 10 (59%) or respondents said they intended to add more to their Cash ISA in this tax year or next, no doubt in part thanks to the pandemic savings turbo-charging cash balances, as spending options have dried up.

While this is encouraging from the point of view of short term financial security, it does mean savers are sitting on cash for the long run, missing out on potential returns from other assets, and seeing the buying power of their cash eroded by inflation. Clearly there is a balance to be struck here between having a robust safety net, and seeking higher returns by investing in the stock market, which can lead to a loss of capital in the short term. Typically, savers should seek to have 3 to 6 months of expenses in cash to deal with any emergencies, beyond that they should seek to tilt the balance between security and return more towards the latter.

Three to six months of expenses equates to £7,613 to £15,226 for the average household, which may well have two Cash ISA savers in it. This broadly ties in with the view expressed by the FCA in December, that those with more than £10,000 held solely in cash were missing out on the historically higher returns from investing their money, and opening themselves up to inflation risk.****

There are some reasons why you might want to hold more than six months of expenses in an ISA, namely if you are saving for a specific goal, for instance a house deposit. This probably explains a surprising kink in the data, which shows that younger savers actually have more held in Cash ISAs than older generations.

Broadly speaking, if you think you may need access to your money within five years, then cash might be the best option. If you’re putting money away for five to ten years, then you should start to think about putting at least some of it in the stock market. If you’re putting cash away for more than ten years, then an approach that invests more heavily in the stock market is likely to yield significantly better results.

Cash ISA inertia

Cash ISA savers aren’t paying a great deal of attention to the rate they’re getting, and who can blame them, seeing as picking cash products right now is about selecting the least worst option. Our survey found that on average Cash ISA holders hadn’t reviewed their rate for two and a half years, over which time the average Cash ISA interest rate has more than halved, from 0.9% to 0.4%, according to Bank of England data. Worryingly, almost a quarter of Cash ISA savers (23%) said they hadn’t reviewed their cash ISA rate for 5 years or more. This goes some way to explaining why 25% of Cash ISA savers reported getting over 1% interest, which looks unrealistically high in today’s market.

Despite holding a Cash ISA for an average of 8.5 years, 45% of Cash ISA savers said they have never switched provider. Half of these savers said it was because rates were so low, it didn’t seem worth it. That’s perfectly understandable, though for those with large sums in Cash ISAs offering poor rates, the difference can still be significant.

20% of Cash ISA savers said they held £50,000 or more in their Cash ISA. If they were picking up a high street rate of 0.1% (see table below) on £50,000, simply by moving to an account providing the average rate of 0.4% they could make an extra £150 a year. Not a king’s ransom, but worth having in your pocket rather than the bank’s. Particularly when you consider that at a rate of 0.1%, the total interest you are receiving is £50, and by moving to an account paying 0.4%, you would be quadrupling that amount to £200.

Selected high street instant access Cash ISA rates

Switching to a Stocks & Shares ISA

Half of Cash ISA savers surveyed (51%) said they had considered switching to a Stocks & Shares ISA. It used to be the case that you couldn’t cross the streams, but since 2014 you have been allowed transfer money from a Stocks and Shares ISA to a Cash ISA, and vice versa.

Doing so may be worthwhile if you feel you’ve got too much sitting in cash, earning next to nothing, and you’re willing to keep your money invested for the long term. You must be willing to tolerate falls in the value of your capital however, but the reward should be higher returns in the long run.

It’s important to always maintain a cash buffer for emergencies, three to six months of expenditure is the rough rule of thumb, but beyond this, you can start to think about investing in the market. Instead of transferring you might consider funnelling some of your new savings into a Stocks and Shares ISA, thereby gradually reducing your reliance on cash. Investing in the stock market bit by bit also helps to take the edge off the inevitable bumps in the road.

Please continue to utilise these blogs and expert insights to keep your own holistic view of the market up to date and for advice and planning tips.

Keep safe and well.

Paul Green DipFA

22/03/2021

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VW charges up for electric vehicle push

Please see the below article from AJ Bell received late yesterday afternoon:

German auto maker has grand plans for global EV market

In August 2020 we flagged German auto maker Volkswagen as a value play at €139, since when the stock has gained more than 40%.

Its shares have been particularly strong this year as the firm rolls out its electric vehicle strategy, culminating in this week’s ‘Power Day’.

In contrast, electric vehicle specialist Tesla has had a torrid time this year with shares tumbling from $900 in January to a 2021 low of $563.

VW has grand plans for a big electric vehicle push. As well as reducing the cost of ownership in the space it is investing heavily in new battery technology to improve range and in new charging networks to improve ease of use.

The company aims to reduce battery prices to below €100 per kilowatt hour through a combination of advanced cell design and lower manufacturing costs, all while using green energy.

Beginning with a €14 billion investment in Sweden with partner Northvolt, VW aims to have six gigafactories in Europe by 2030 with a combined capacity of 240 gigawatt hour.

More significantly, VW has partnered with BP, Spanish utility Iberdrola – a world leader in green energy – and Italian utility ENEL to install 18,000 new high-power charging stations across Europe.

The current lack of infrastructure is seen as a key reason for the slow mass adoption of electric vehicles. By working jointly to create a network of renewable-powered rapid-charging stations, each company gets closer to its net-zero goals to boot.

However, VW has even grander plans. All of its electric vehicles come with a home-charging station called Elli. When parked and connected to the Elli Cloud, a VW ID.3 becomes a ‘mobile power bank’ capable of feeding power back to the house for up to five days.

Using intelligent management systems, energy could be transferred to the vehicle during off-peak hours and transferred back to house when needed.

Not only would this save wasting renewable electricity – last year Germany wasted 6,000 gigawatt hours of renewable energy due to lack of storage – when rolled out to commercial and industrial customers it could drastically reduce the cost of expanding transmission networks.

Renewable energy is likely to be an area of rapid growth over the next few years. As the world navigates its way out of the Covid-19 pandemic, the world has been left with food for thought about how to make the planet better and how to sustain it. Companies around the world are adapting to renewable energy sources.

We regularly post a variety of ESG content, both our own and articles from a range of fund managers, and renewable energy is a key consideration in this (the E in ESG, E – Environmental).

This is definitely an area to watch!

Keep checking back for a range of blog content from us, from ESG outlooks, to market updates and insights, both our own original content and input from a wide range of fund managers and investment houses.

Andrew Lloyd

19/03/2021

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Why bank stocks are getting bashed (again)

Please see the below article from AJ Bell, published late last week:

The sector is one of the worst performing over the last 12 months and past decade.

Fresh allegations from the International Consortium of Investigative Journalists (ICIJ) about money laundering at HSBC (HSBA) and Standard Chartered (STAN), among other leading global banks, may pertain to wrong-doing which is already covered by previously-paid regulatory fines, according to the lenders themselves.

But even if that is the case, the story gives investors another reason to wonder whether banks stocks are worth the bother, given their complex business models, the danger that loan books are harbouring a lot of debt that might be about to go sour if the economy turns down again and the threat posed by central banks’ monetary policy.

This is not how central banks see it. They argue that cutting interest rates and quantitative easing (QE) lower borrowing costs, creating demand for loans and credit that keep economies going.

But equity investors are clearly not convinced. Within the FTSE 350, banks are the third-worst performing sector over the last 12 months (ahead of only Oil Equipment & Services and Oil & Gas Producers) and the second-worst over ten years (beating just Oil Equipment).

This is a serious matter for holders of the Big Five FTSE 100 banks’ shares and those investors who get access to UK equities via passive, tracker funds – those same five banks represent 7% of the FTSE 100’s market capitalisation and, according to consensus analysts’ forecasts, are set to generate 12% of the index’s 2021 profits and 14% of its dividends.

Mangled margins

The problem, at least in the near term, is that low base rates drag down the interest rates that banks can charge on loans. Quantitative easing is designed to flatten out borrowing costs, too, so that credit spreads (the premium in interest rate paid by a company to a government) are also relatively narrow.

The net result is that the net interest margin on banks’ loan books is under fierce pressure, seriously undermining banks’ profitability and their ability to earn decent returns on equity.

An average decline in the net interest margin across the Big Five FTSE 100 banks of 52 basis points (0.52 percentage points) since Q1 2017 might not sound a lot. But that represents a 22% drop in the lending margin and on their current aggregate loan books of £2.2 trillion. That is the equivalent of £10 billion in interest a year – profit which could have been used to make fresh loans, perhaps, buffer balance sheets or even pay dividends to shareholders.

Some investors could be forgiven that the Bank of England’s monetary medicine is making banks feel worse, not better.

Global trend

In Europe, the European Central Bank has been tinkering with zero interest rates (and negative deposit rates) for some time, to no great effect so far as its 2% inflation target is concerned, but with deleterious consequences for banks’ profits and the returns on offer to their equity holders.

Unfortunately, investors in banks had already been warned of what might come their way. After all, the Bank of Japan has been fighting the effects of the bursting of a debt-fuelled stock market and property bubble since 1990, some 17 years before a similar fate befell the UK, Europe and America.

The effects of three decades of QE and ZIRP upon Japanese banking stocks are all too clear to see in the miserable share price peformance, and the Bank of Japan’s record in promoting consistent economic growth and 2% inflation, in line with its target, is spotty at best.

Only US banking stocks have shown any real signs of life in the past few years but the pandemic, a recession and reversal of Fed policy from tightening to easing appear to have taken care of that in 2020.

American dream

The disconnect between the market cap weighting and the estimated profit and dividend contribution means that either the FTSE 100 banks are too cheap or market doesn’t believe the analysts’ forecasts for 2021.

The experience of America’s investors suggest that banks’ profits and share prices need rising bond yields, as that may help lending margins, so that may be the catalyst that contrarian value seekers crave, although what it could do to their loan books when it comes to sour loans and impairment charges is another matter.

Economic growth and (some) inflation would be potential triggers for bond yields to rise. Central banks continue to strive for both and are now calling for further fiscal stimulus to help.

Until governments sanction more spending and higher deficits, banking stocks may continue to recoil from central bank policy statements which promise low interest rates for longer or even the dreaded prospect of negative interest rates, to the detriment of individual bank stocks and perhaps the wider FTSE 100 index.

Please continue to check back for our latest updates and blog posts.

Andrew Lloyd

28/09/2020