what-we-said-10-years-ago

February 2014 Investment Report

Why Are We Here?

I again have a substantial amount of research to share with you this quarter and for those who are unable to find the time or do not wish to read the detail of this report, I summarise below the matters covered and my findings and interpretations:-

Average stock market valuation ratio’s for the last seventeen years have exceeded the average ratio’s for the previous one hundred years;
Having investigated emerging market growth, globalisation, productivity efficiency, the velocity of money and total debt to GDP (Gross Domestic Product), it would appear that total debt to GDP is the only factor which is currently higher than at any other time in the previous 100 years and this stock market advance has therefore largely been financed by leverage;
The US stock market is likely to fall by between 64% and 89% and to adversely affect all other stock markets around the world;
Central bankers are being overburdened by governments with responsibility for inflation, unemployment and growth, this is likely to lead to monetary policy remaining looser for longer and a long term rise in inflation;
Solvency problems are being masked by low interest rates and easy credit;
Central Bank independence is not credible and is coming to an end;
Sub-par economic growth is likely to last two decades or longer;
The endgame to the global financial crisis is likely to require some combination of financial repression (an opaque tax on savers), outright restructuring of public and private debt, conversions, somewhat higher inflation, and a variety of capital controls under the umbrella of macro prudential regulation (financial regulation aimed at mitigating the risk of the financial system as a whole).';
A massive monetary policy easing may be required to avert a collapse of Great Depression proportions;
We are now at the point where we see the peak of the banking crisis (if there is no default) or there is a default on external and/or domestic debt together with inflation worsening and the peak of the banking crisis. Capital controls (transaction taxes, other limits and/or outright prohibitions to regulate flows from capital markets into a country's capital account) and financial repression are then introduced or increased;
Based upon the relationship of gold to the amount of US dollars in circulation, I anticipate a gold price of in excess of $13000 an ounce within the next ten years and that the real price of gold will attain new peaks. On this basis the average rate of inflation for the next ten years will exceed 20% per annum;
Gold is significantly undervalued relative to the wage of a Roman Legionary compared to that of a US Army Private;
If emerging countries boosted their holdings of gold on both per capita and per GDP basis to levels that more closely reflect the experience of more developed markets and there were a widespread move to increase gold in diversified portfolios, this would lead to substantial upward pressure on the nominal and real price of gold;
Dominic Picarda of the Investors Chronicle sees gold going to $3000 an ounce and more and points out that in the mid 1970’s gold halved midway through its bull run before it then soared 700%. He believes that we may be due something similar this time.
US earnings before interest, tax and depreciation have been flat for two years, whilst the stock market has gained 40%. So the ‘growth’ achieved over the past two years appears to be the product of accounting manoeuvres and little else;
Over sixty years of highly correlated data suggest that the US stock market will produce a nominal return of close to zero over the next ten years. That is before inflation, charges and taxation;
According to The Economist, Britain’s home prices are approximately 30% over valued.

Why Are We Here?

This is not a philosophical question concerning the meaning of life. It is a question that I have been concerned with for many years, relating to the long term value of all investment markets and in particular stock markets. The Cyclically Adjusted Price Earnings Ratio (CAPE) (Price divided by ten year average earnings, adjusted for inflation) and Tobin's Q (The ratio between the value of the stock market and the replacement value of the same physical assets) are generally regarded as the best method of identifying the long term value of stock markets and indeed they have continued to be so, offering good clues to overvalued stock markets which have performed relatively poorly for the last fourteen years. Nevertheless, the questions that I have had to consider are:-

Why have the valuations of these ratios on average for the last seventeen years exceeded the averages for the previous one hundred years?
Are these higher valuations sustainable?
What will the level of the ratios be at the low point, so that we can identify when it is safe to take long term positions in stock markets and other conventional assets such as property?

Many investors argue that higher stock market valuations are justified due to increased globalisation. Increased globalisation can be measured by increased global trade in goods and services. Information from the World Bank World Development Indicators demonstrates that global growth rose by approximately 200% in the 1970's, by around 65% in the 1990's and by around 66% in the 2000's. Stock market valuations were much lower in the 1970's than they were in the 1990's and it is therefore likely that globalisation does not explain higher stock market valuations.

Related to globalisation is the growth of emerging markets. There are two documents that provide a comprehensive analysis of emerging markets, the IMF staff discussion document – 'Anchoring Growth: The Importance of Productivity-Enhancing Reforms in Emerging Markets and Developing Economies' and the Peterson Institute working paper 'Why Growth in Emerging Economies Is Likely to Fall'. The 1970's marked a period of generally lower CAPE and Tobin's Q and what might be informative here is that this was a period of falling trend growth rates in emerging markets, whereas in the 1990's and early 2000's growth rates in emerging markets were trending upwards.

Higher trend growth rates in emerging markets tend to lead to an export of the lower wages in those countries and consequently a fall in inflation and higher developed stock market valuations. Both papers confirm that some deceleration in economic growth in fast-growing emerging markets is inevitable as convergence gaps close and demographic tailwinds fade. This trend is confirmed by data in recent years and in my opinion is likely to lead to a rise in inflation and lower developed stock market valuations as it did in the 1970's.

Whilst the trend in growth rates in emerging markets is closely correlated with developed stock market valuations, these trend growth rates have not been greater than historically evidenced and do not therefore explain the current excessive valuation in developed stock markets when compared to previous years.

Productivity gains lead to higher stock market valuations as companies are able to produce more turnover and profit for each unit of capital and labour employed within their businesses. A National Bureau of Economic Research paper called 'Revisiting US Productivity Growth over the Past Century with a View of the Future' demonstrates that the annual growth rate of actual and trend total economy output per hour in the last seventeen years has been no higher than the peaks of the 1950's when stock market valuations were much lower. The paper identifies 'by far the most rapid period of Multi-factor Productivity Growth in US history occurred in 1928 to 1950'.

The paper forecasts a 1.5% growth rate of per-capita real GDP for the next twenty years which falls short of the historical achievement of 2.17% between 1929 and 2007 and represents the slowest growth of the measured standard of living recorded during the past two centuries. Lower output per hour in the 1970's coincided with lower peak stock market valuations and can therefore be considered as contributing to the trend in stock market valuations, but the evidence does not support the view that recent levels of productivity growth are responsible for excessive stock market valuations. To do so productivity growth now would have to be greater than it was in the last 100 years and it is not.

Lower inflation produces lower interest rates, which leads to higher stock market valuations. I therefore considered what causes inflation and it is generally regarded that inflation is a monetary phenomenon. The more rapidly a unit of currency is circulated within an economy the more inflation should be created. There is clear historical evidence over short time periods of two to five years that changes in the money velocity leads to rises and falls in inflation, but I was surprised to see data from the US Bureau of Labour Statistics which shows that the low inflation of the late 1990's, experienced a much higher velocity of money than the high inflation 1970's. Long term money velocity cannot therefore be the reason for differences in inflation and stock market valuations.

Finally I looked at total levels of debt to GDP. Current levels of debt to GDP in the United States are currently 20% higher than in the 1920's when debt and stock markets attained their previous historical peaks. Stock market peaks of the 1970's which saw peak valuations 25% lower than the 1920's also experienced much lower levels of total debt to GDP. The run up in stock market valuations in the last two years has again been supported by increased debt levels but this time, higher corporate and government debt rather than personal debt. The correlation between high levels of debt and high stock market valuations is clear. The money that is created by debt finds its way into conventional assets, driving up valuations as investors speculate on ever greater returns and the need for an income from their investments, leading to the worst possible investment metrics of low yielding assets supported by high levels of debt.

In answer to the questions raised at the beginning of this report:-

Emerging market trend growth rates, inflation and levels of debt to GDP have clear links with long term valuations and do go some way to explain high stock market valuations. Whilst globalisation and productivity gains have clear links with stock market valuations, they are no greater than at previous market peaks and do not therefore support the argument that stock markets today should be more highly valued than in the previous one hundred years.
In the future, emerging market trend growth rates are likely to be lower, inflation higher and debt levels lower. Consequently stock market valuations are likely to trend lower. Hence, these valuations are not sustainable.
Future growth rates, inflation and debt are likely to dictate the low point in valuations and will be reinforced by rates of globalisation and productivity gains. Globalisation has already weakened and may weaken further as economies become more insular in order to protect their own markets in times of difficulty. Productivity gains are falling and will continue to fall as companies have insufficient capital to invest sustainably in new technology for future efficiency gains. I have always maintained that we will take long term positions in stock markets when the CAPE and Tobin's Q are below their historical averages. The absolute levels at which they become attractive will be a moving target, but current valuations suggest that the US stock market in particular needs to fall by at least 64% and perhaps as much as 75% and that inflation adjusted returns will be negative for up to ten years.

The historical omens for the stock market are not good. The last time that debt to GDP and stock market valuations were so high (debt is now higher) was in 1929 following which the US stock market fell by 89% within three years and took sixteen years to fully recover its losses adjusted for inflation and sustain those gains and that is before taxation and charges!

A Bank for International Settlements working paper entitled 'Is monetary policy overburdened?' provides the following observations:-

'Overburdening monetary policy may lead to the repoliticisation of central banking. As more responsibilities are allocated to the central bank, the incentives for political capture and misuse by governments increase. Overburdening monetary policy may eventually diminish and compromise the independence and credibility of a central bank, thereby reducing its effectiveness in maintaining price stability and contributing to crisis management'
'The availability of cheap credit may have significant adverse effects on the incentives for political authorities to correct fiscal problems. When the central bank provides all the financing a government needs at near zero cost, it is easier to postpone dealing with a problem rather than risk the short-term political cost that would be associated with any solution. The risk of facilitating this postponement, of course, is that the fiscal problem only gets bigger when not tackled in a timely fashion.'
'A more direct risk, potentially threatening the credibility and independence of a central bank, is associated with financial stability considerations during the clean-up phase of a crisis. As we have observed during the current crisis, a massive monetary policy easing may be required to avert a collapse of Great Depression proportions. The associated provision of liquidity at near-zero interest rates has a number of characteristics that could cause unpleasant side effects for the central banks.'
'The valuation of the collateral pledged against the provided liquidity is harder to assess with precision and a shortfall in liquidity may become difficult to distinguish from an underlying solvency problem. If a solvency issue were to appear, the continued provision of liquidity for extended periods (and at very low interest rates in the aftermath of a crisis) could potentially mask a solvency problem.'
'In the extreme, a politically captured central bank could succumb to government pressure for it to provide emergency liquidity assistance to an insolvent bank, effectively undertaking a fiscal operation by stealth and helping the government hide the problem from public view.'
'The central bank may be faced with a dilemma: Continue to keep interest rates low to avoid banking problems at the cost of higher inflation, or raise interest rates and accept the risk of one or multiple bank failures and their economic consequences.'
'In the absence of a well-defined and sufficiently strong fiscal backstop, the post-crisis clean-up could turn the provision of liquidity at very low rates into a mechanism for recapitalising banks. Without workable alternatives, this may create doubts about the willingness of the central bank to exit an environment of exceptionally accommodative monetary conditions when macroeconomic conditions would have warranted such a policy change. Such doubts could compromise the credibility of the central bank.'

As an addendum to this paper, Niall Ferguson (Professor of History at Harvard University) adds the following comments:-

'Central bank intervention has always been contingent on the requirements of the state. It should not in the least surprise us if we see central banks ceasing to be 'the only game in town' and reverting to their original historical role as helpmeets for government finance. This has in fact already begun, and seems likely to continue'
'Today central banks appear – and may even believe themselves – to be 'the only game in town'. But this is an illusion. Imperceptibly, they have been reverting to the role they last played in the 1940's, as vehicles for financing government deficits at artificially low interest rates. In Japan, the subordination of the Bank of Japan to the government is already a fact.'
'The issue is not whether or not inflation targets are to be joined by additional targets. The issue is whether or not the era of central bank independence is coming to an end. If it is, we shall look back on the idea of central banks as the only game in town as hubris comparable with the idea of a great moderation (a highly questionable Ben Bernanke hypothesis which led lower interest rates between 2001 and 2003 to house price inflation peaking in 2006 and the Great Recession of 2007-09) - to be followed equally quickly by nemesis.

Scott Minerd (Global chief investment officer at Guggenhein Partners) – ‘The judgement of history waits as to whether the new monetary orthodoxy Mr Bernanke created will result in draconian consequences for markets and the economy, as some fear. If and when Mephistopheles (a devil to whom you have sold your soul) calls, it will be incoming Fed chairwoman Janet Yellen who holds not only the legacy of Mr Bernanke but of the Fed itself in her hands.

The IMF Working Paper 'Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten' makes the following observations:-

'Research shows that a debt overhang of this size is typically associated with a sustained period of sub-par growth, lasting two decades or more. In light of this dim prospect, the paper reviews the possible options, concluding that the endgame to the global financial crisis is likely to require some combination of financial repression (an opaque tax on savers), outright restructuring of public and private debt, conversions, somewhat higher inflation, and a variety of capital controls under the umbrella of macro prudential regulation (financial regulation aimed at mitigating the risk of the financial system as a whole).'
'On prevention versus crisis management. We have done better at the latter than the former. It is doubtful that this will change as memories of the crisis fade and financial market participants and their regulators become complacent.'
'The magnitude of the overall debt problem facing advanced economies today is difficult to overstate. The mix of an ageing society, and expanding social welfare state, and stagnant population growth would be difficult in the best of circumstances. This burden has been significantly compounded by huge increases in government debt in the wake of the crisis. The emerging markets actually deleveraged in the decade before the financial crisis, whereas advanced economies hit a peak not seen since the end of World War II. In fact going back to 1800, the current level of central government debt in advanced economies is approaching a two-century high-water mark.'
'Unlike central government debt, for which the series are remarkably stationary over a two-century period, private sector debt shows a marked upward trend due to financial innovation and globalization, punctuated by volatility caused by periods of financial repression and financial liberalization. The degree of deleveraging after the financial crisis has been limited. In essence, the advanced countries have exercised the government's capacity to borrow, even after a crisis, to prop up the system. This strategy likely made the initial post-crisis phase less acute. But it also implies that it may take longer to deleverage.'
'Given the magnitude of today's debt and the likelihood of a sustained period of sub-par average growth, it is doubtful that fiscal austerity will be sufficient, even combined with financial repression. Rather, the size of the problem suggests that restructurings will be needed, particularly, for example, in the periphery of Europe, far beyond anything discussed in public to this point. Of course, mutualisation of euro country debt effectively uses northern country taxpayer resources to bail out the periphery and reduces the need for restructuring. But the size of the overall problem is such that mutualisation could potentially result in continuing slow growth or even recession in the core countries, magnifying their own already challenging sustainability problems for debt and old age benefit reforms.'
'Debt overhang episodes averaged 1.2% lower growth than individual country averages for non-overhang periods. Moreover, the average duration of the overhang episodes is 23 years.'

The paper includes an interesting flow chart depicting the sequence of crises. It begins with financial liberalisation, leading to a stock market and property crash and the beginning of the banking crisis. Currencies then crash and inflation usually picks up (as it did in 2011). We are now at the point in the flow chart where we see the peak of the banking crisis (if there is no default) or there is a default on external and/or domestic debt together with inflation worsening and the peak of the banking crisis. Capital controls (transaction taxes, other limits and/or outright prohibitions to regulate flows from capital markets into a country's capital account) and financial repression are then introduced or increased.

‘The Golden Dilemma’ is a comprehensive historical analysis of gold by Claude B. Erb of Los Angeles and Campbell R. Harvey of Duke University, USA. It raises interesting pieces of research, many of which I would interpret differently to the authors:-

Based upon historical evidence they produce a table on the inflation adjusted price of gold at the end of a ten year period and the annual inflation rate over that ten year period. They suggest that if the real price ratio of gold mean reverts over the coming decade to its historical average of about 3.2, the average annual rate of return for gold over the next ten years will be -6% per annum. However, I believe that there mean reversion assumption is incorrect as it has not yet attained our expected inflation adjusted peak. Based upon the relationship of gold to the amount of US dollars in circulation, I anticipate a gold price of in excess of $13000 an ounce within the next ten years and that the real price of gold will attain new peaks. On this basis the table suggests that the average rate of inflation for the next ten years will exceed 20% per annum. This is more consistent with the rational expectations of those that expect the current global money printing experiment will produce high inflation, as it has done in the past (on each single country basis);
They demonstrate that the highest US inflation rate in the last 220 years occurred under the fiat money regime (a currency without intrinsic value and not fixed in value in terms of any objective standard such as gold), but they then attempt to weakly argue that neither a fiat money system or a gold system is inherently prone to inflation;
Roman legionaries were the lowest ranking soldier in a Roman legion, similar to a private in the US Army today. A Roman legionary was paid the equivalent of 2.31 ounces of gold 2000 years ago and today a US Army private is paid the equivalent of 11.01 ounces of gold. They use this to suggest that gold has not kept pace with inflation. If they looked at the figures for 1980 they would probably find that gold did keep pace with inflation over the last 2000 years. To me, the difference in pay reaffirms my view that gold is undervalued and based upon their evidence should rise to $7626 an ounce;
They compare the value of gold against many currencies, but not against the value of the US dollar, which is the world’s reserve currency and this would appear to be a significant omission;
They provide evidence that the real price of gold has been closely correlated with real interest rates between 1997 and 2012 and then weakly attempt to deny that it is;
They suggest that gold does not perform well during periods of hyperinflation and to do this they take the Brazilian currency since 1980 (the peak point in the price of gold) and show that during the hyperinflation Brazil suffered from that point, gold underperformed the Brazilian currency by 70%. I would again argue that this suggests that gold is undervalued in Brazilian Real and in order to address that undervaluation, the price of gold now needs to rise to around $5333 an ounce;
I quite like their point that we should not just relate the value of Gold to the amount of US dollars but to global money in circulation. If we did this and applied it to the 1980 peak in the price of gold, the amount of global currency in circulation has now increased 15 fold and that suggests that the gold price should currently be $12750 an ounce, which is coincidentally the suggested value based upon the amount of US dollars in circulation;
They quite rightly identify that excess demand has driven the real price of gold. However, it is important to note that only investment demand has a strong correlation with the price of gold;
They recommend a portfolio split which includes a 2% allocation to gold, but that would be based upon assets having a portfolio split weighted upon their value. The problem with this rationale is that the portfolio would have a value bias and overvalued assets would have a much bigger impact on returns than undervalued assets, when investors ought to be creating portfolio’s which are based upon an overweight to undervalued assets;
They contend that if emerging countries boosted their holdings of gold on both per capita and per GDP basis to levels that more closely reflect the experience of more developed markets and there were a widespread move to increase gold in diversified portfolios, this would lead to substantial upward pressure on the nominal and real price of gold.

You will notice that I have made several different predictions of what the price of gold might be and this is because I have compared it against different assets and in today’s values and potential future values. Each of these is variable and not necessarily correlated with one another. The important point to remember is that gold is considerably undervalued and should rise in value over the next seven years.

According to the Federal Reserve and World Gold Council, the market capitalisation of above the ground gold is now 3.9% of total US financial assets compared to 19.6% in 1934 and 21.8% in 1982.

Gold analysts are now at their most bearish since 2002, a year which saw the price of gold rise approximately 25% from $278 to $347 an ounce.

Dominic Picarda of the Investors Chronicle sees gold going to $3000 an ounce and more and points out that in the mid 1970’s gold halved midway through its bull run before it then soared 700%. He believes that we may be due something similar this time.

More Stock Market Warnings

Andrew Lapthorne (quantitative equity strategist at Societe Generale) points out that MSCI (Morgan Stanley Capital International) US earnings before interest, tax and depreciation have been flat for two years, whilst the stock market has gained 40%. So the ‘growth’ achieved over the past two years appears to be the product of accounting manoeuvres and little else. The con trick will shortly be shown for the illusion that it is, but as with all illusionists, they will not admit how they have executed their trick and it is left for you to work it out. Hopefully, our reports are assisting in understanding these deceptions.

Albert Edwards (Societe Generale) – ‘No one can hear me scream above the roar of the printing press’

Shares in Twitter hit a high on December 26th, valuing the company at 40 times projected 2014 earnings or a little more than 1000 (yes, one thousand) times possible profits for 2013. The social media sector generally is the same. This smells like the 1999 tech bubble all over again.

Bid multiples for Global Mergers and Acquisitions are 40% higher than in 2000 and 20% higher than in 2007, they being previous stock market peaks.

James Mackintosh, FT – ‘Investment trusts are trading at their highest valuations for more than forty years. Only three times since 1970 has the discount been below 5%, according to the Association of Investment Companies.’

‘Bulls now outnumber bears fourfold, by far the highest ratio since 1987.

John Plender, FT – ‘The US political class has been bought by Wall Street bankers with an efficiency and cynicism not seen since Cosimo de Medici bought up the 15th century papacy. At these market levels, future equity returns will be more subdued’.

‘The commitment of China to open its capital account, reinforced at the leadership’s recent third plenum, could prove disruptive for global markets. If there is a substantial outflow of hitherto trapped savings, the Chinese authorities might have to sell US Treasuries held in their official reserves to prevent a collapse of the remnibi. That could seriously threaten financial stability in the US.

John Authers, FT – ‘The current combination of high dispersion with low volatility is odd, and has in the past shown itself when a bubble is forming, as in 1999 and again before the credit crisis. A bubble is a good time to gather assets for a while, but in the long run it damages public faith in the equity market. History has been far kinder to the value managers who sat out the bubble – even though they cursed themselves for doing so at the time. Bubbles also confront managers with painful choices between short and long term targets.

US leveraged finance volume is now at a peak as it was in 1998 and 2007, prior to previous stock market peaks.

Merryn Somerset Webb, FT – Based on last year’s profits, the price earnings ratio of the US S&P 500 Index has risen to 19.1 times. This is not about companies being worth more. It is about people paying more.

Edward Luce, FT – We are entering Wall Street bubble territory before the real economy has started to hum. The US and UK recoveries have been bought with historically easy money, which have fuelled asset price booms that are already starting to look expensive. The US labour force participation rate is stuck at its lowest level in almost 40 years, whereas the US equity market’s price to earnings ratio is already well above average. The US and especially the UK are exhaling a sigh of relief that things are not worse than they are. But they should not downplay the high price at which growth has been bought. Nor should they delude themselves that good times are round the corner.

Jeremy Warner, Telegraph – ‘What’s so frightening is we’ve yet to hear anyone articulate a credible strategy for freeing advanced economies of their addiction to central bank money. Claudio Borrio of the Bank for International Settlements diplomatically expresses no opinion on whether the current combination of tight spreads (differences in risk interest rates) is sustainable, so let me do it for him; no it is not.

BlackRock – ‘Measuring ‘enterprise value’ against earnings, adjusted for volatility is almost as high as it was just before the dotcom bust. The ratio of the two is the key. High valuations combined with low volatility can make for a lethal mix. This market gauge sounded the alarm well before the Great Financial Crisis.’

Hussman Funds – the following assessments are based upon data going back to 1950 for the US stock market and all have very high levels of correlation during the past sixty years:-

The three year change in government and personal spending as a percentage of GDP currently suggest that the three year annual growth rate in corporate profits will be nearly -5% per annum;
Corporate profits after tax and divided by GDP currently suggest that annual profit growth will be -19% per annum for the next four years;
Stock market capitalisation of non-financial assets to GDP currently suggest that total returns for the US S&P 500 Index will average -1% per annum for the next ten years;
The S&P 500 Price to Revenue Ratio currently suggests that the total return from the S&P 500 Index for the next ten years will average 2% per annum.

UK Economy

Satyajit Das (former banker and author of ‘Extreme Money’ and ‘Traders, Guns and Money’ – Increasing reliance on forward guidance is drawing unwanted attention to the limitation of central banking instruments and policy. To any casual observer, it resembles the unarmed English policeman in comedian Robin Williams’ sketch trying to apprehend a fleeing suspect with the exhortation: ‘Stop! Or ….I’ll shout stop again!’’

Rent arrears have doubled in the last six years.

US Economy

The headline unemployment rate has fallen to 6.7%, whereas the total of unemployed actually able and willing to work has actually fallen from 17.4% to 13.1% according the U-6 rate provided by the Bureau of Labour Statistics.

The US Misery Index (combination of inflation and unemployment) reached its lowest point in 42 years in 1998 and has since been rising. Using historical data and cycles, the next peaks are likely to be in 2015, 2020 and 2025 with each peak being higher than the last.

Inflation/Deflation Debate

Michael Aronstein (Mainstay Marketfield fund) has produced double the return of the S&P 500 Index over the last six years – ‘The only period that may be comparable to this is after the discovery of the New World, when all the Europeans looted all the gold and silver, new money out of the sky, a la the Bernanke Doctrine. You had, basically, a century of inflation in Europe. The tulip bubble didn’t come out of nowhere; that wasn’t just people’s appetite for flowers.’ He and his team pore over price data from hundreds of commodities and manufactured goods. It is outwards from these pressure points, he says that the world will finally move from asset price inflation to real consumer price rises.

Money Moves Markets – In the UK, broad money can grow by more than about 3.5% per annum to be consistent with the 2% inflation target, assuming potential output expansion of 2.5%. Current monetary growth – an annual 4.4% in October – is, therefore too high. In the US the divergence between the unemployment rate and the vacancy rate suggests that the ‘natural’ rate of unemployment has risen significantly. Limited slack suggests that price and wage pressure will revive sooner than the Fed and the consensus expect if the economy continues to expand at its recent pace.

The cost of US shale production is said to be profitable above $80 to $90 a barrel, so oil prices are unlikely to fall below these levels for any length of time.

Kopernik Global Investors – ‘It seems clear that the likely outcome is a systemic default on systemic debt in real terms so that nominal defaults can be avoided. Inflation has always been the political solution throughout history, and current trends and logic support its future endorsement. Claims on demand-inelastic global resources and production are the ultimate sovereign currency, regardless of their provenance. That’s where we think substantial alpha (risk adjusted returns) in the equity markets resides today.’

Property

According to the Economist house-price indicators, the most over priced homes (adjusted for their long run averages) in the world can now be found in Belgium, France and Canada. Britain’s homes are between 26% and 36% over valued. The most under priced homes can be found in Japan, China and Germany.

Currencies

According to the Economist Big Mac Index, the world’s most expensive currencies are in Norway and Switzerland and the weakest are in India and South Africa. Due to the extraordinary world economic environment, these trends may be extended as investors again seek safe havens and avoid areas of risk.

Behavioural Finance

Investors generally are irrational. They become more irrational at market extremes, making decisions based upon emotions rather than facts. Psychological factors influence investors and lead them to reach incorrect conclusions that are not necessarily rationale. Investors are optimistic as markets rise and pessimistic as markets fall. Investors tend to put too much weight on recent experience and extrapolate recent trends, which leads to excessive trading and speculative bubbles.

It is part of my job to assist you with understanding these emotions and reinforcing decision making with facts which support a good long term investment strategy.

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The views reflected herein are those of Vertis Private Wealth Management Limited and should not be regarded as a recommendation to invest in any one product or service; before investing you should always consider personal investment advice.

Where you seek the advice of Vertis Private Wealth Management Limited we continually monitor markets and will advise you where there is a change in the findings of our research and provide advice and guidance on any alterations that may be required to the investment strategy that we have previously recommended.

Vertis Private Wealth Management Limited does not accept any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. Investors should be aware that the value and income from investments can rise and fall and that past performance should not be considered as a guide to the future.

Vertis Private Wealth Management Limited – February 2014