Eddie's Rocket

C L I M A T E

As expected 2008 has started with the bears in full roar, plenty of gloom about and lots of nerves as the Armageddonists prowl the media. So what’s happening and what’s still right for long term investment?

In terms of the long-term trend I am firmly convinced that it will be marked by increased volatility as the oil age is replaced by the alternative energy age. This represents substantial opportunities to be the right side of this equation over the long-term. Here you’ll find a detailed article I published with the Sunday Business Post as 2007 closed out.

In the short-term, much depends on the US and the near certainty of a US recession followed by a recession in the UK. If a recession in the US is shallow the likelihood is that developing markets will be largely unaffected protected by their own internal growth momentum. A recession is defined as two consecutive quarters of negative growth, even though growth for the year could be positive.

Aggressive rate cuts by the US FED and by the Bank of England are unlikely to be enough to soak up the credit binge in each of these economies, in my view. Europe, on the other hand, is in much better shape where budget deficits are low and consumers have avoided over-borrowing.

Emphasis on European Equities

Two years ago we’d recommended strategic switches out of US assets mostly in favour of funds holding European large stocks with strong cash balances and good track record in paying dividends, i.e. principally utilities, financials and telecommunication companies. We also favoured European value stocks and growth stocks. Europe still remains the linchpin of our recommendations with regards to investing in equities, for the long-term.

In terms of broader diversification, we continue to recommend the Pacific region, which will provide exposure to Japan, Australia, etc., and India and China, but this year we are adding the Middle East, concentrating on Turkey, Egypt and Israel. In terms of timing, prices, particularly in India and China, need to come down for good value to re-emerge.

Unusual Forces

It has to be said that we are facing an unusual confluence of forces, which makes determining the direction of assets difficult until such time as the bad debt story unwinds over the next number of months. This, not only has affected the valuations of financial companies, especially banks throughout the world, but is contributing towards the likelihood of lower growth. If a US recession materialises, which is not shallow, but deep and prolonged, it will inevitably effect growth in developing markets undermining the assumption that the internal growth in these markets is now decoupled from developed markets. Nevertheless, the most likely outcome remains a shallow recession in the US and UK as the imbalances in both economies repair themselves, slowing slightly the growth in China and India by a percent or two.

Interest Rates – The Conundrum

Further US and British interest rate cuts are likely to be followed later in 2008 by cuts in European interest rates.

Falling interest rates should lead to modest growth in the capital value of European Government bonds, which were flat to modestly negative throughout the course of 2007. The conundrum is that this is running in the opposite direction to oil-lead price inflation. If oil prices rise very aggressively then investment in European Government bonds would need to be re-examined. Underneath oil-lead inflationary pressures however, there is little evidence of inflation elsewhere, especially from labour markets as a consequence of the high degree of competitiveness in the globalised economy.

It is likely that returns on retail cash deposits in the Irish market will be negative because of the relatively high level of Irish price inflation due to our high degree of exposure towards imported oil and gas and our failure to control public sector price inflation.

Nevertheless, throughout the course of 2008, we would recommend that any investments are drip-fed into assets until such time as the bad debts story unwinds. This should be bourne in mind when reading about opportunities below.

Property

We continue to remain negative towards Irish residential investment property in particular. The UK commercial property is likely to stagnate after recent declines even though Bank of England should continue interest rate cuts. It is for this reason that I have been recommending investment in European property, especially in Germany, which represents the highest rate of return at the lowest rate of risk in Western Europe, in my opinion. Germany, one of the largest exporters in the world, has recovered from the long period of meeting the costs of German reunification and, unless the Dollar/Euro rate declines very sharply, Germany should continue to recover as a large economy. Rental yields are high in selected German sectors allowing for high gearing and the potential for capital gains with banking finance covered by the buffer of higher rents.

O P P O R T U N I T I E S

You may be familiar with the strategy of FDM Limited, which is to help our clients build a diversified portfolio of uncorrelated assets given the traditional high degree of exposure on Irish balance sheets towards Irish property. In doing so, we use direct assets and we concentrate on a narrow number of asset managers, but who provide us with a substantial fund range, like JPMorgan, which has a huge variety of funds covering most aspects of global investment.

Gold

Gold can be used as a hedge against the falling Dollar for investors exposed to US assets. Gold surges at times of greatest uncertainty. Although currently trading at highs, in excess of $900 per troy ounce, gold prices rise should continue to rise in direct proportion to the decline in the Dollar. You can buy gold directly through any stockbroker in the form of an Exchange Traded Fund such as Lyxor Gold Bullion Securities quoted on the London Stock Exchange.

Property – Direct (Dresden)

Brendan Investments Pan European Property plc was launched during a very difficult climate at the backend of last year and concentrates principally on German commercial property allowing smaller investment access to the upper end of the Pan European commercial property market, which is likely to see substantial support over the next ten years or so. The strong property market which marked the course of the past number of years has come to an end in several markets with declines in areas such as Spain, Ireland, Bulgaria, etc.

But we continue to recommend investing in property markets that have low degrees of risk rather than chasing very high capital appreciation, which is outweighed by the much higher degrees of risk in these markets. It is for this reason that we recommend direct investment in a specific type of German residential property, i.e. within the means of the direct investor.

Brendan Investments Property Management Limited (BIPM) is in a position to organise direct investment in residential investment units, both new and refurbished buildings in Dresden. Known as the “Florence on the Elbe”, Dresden has become the economic centre of Eastern Germany. There is substantial industrial movement within the German market itself towards Dresden and it is also benefiting from tourist growth given the redevelopment of its historic city centre. The population of Dresden is also increasing.

Loan to value of 80% is available through the package arranged by BIPM allowing purchases to take place on the basis of 20% equity down as cash. Capital appreciation has been in the region of 6% to 8% and price growth is likely to continue over the next number of years as rental yields compress.

A complete package is available covering legal costs, notary fees, etc., through BIPM, simplifying the whole process for you.

If you wish to explore building a portfolio of residential investment units in Dresden please send us an email and we will introduce you to Hugh O’Neill, ACA, who is fulltime in Germany as a fulltime director of BIPM. Alternatively, you can email Hugh directly now at hon@brendaninvestments.ie.

Equities – Funds

We continue to favour investment in European large stocks as the main anchor in a long-term equity fund portfolio, concentrating on several fund ranges that provide dividend investing, value investing and growth investing. 

To diversify into fast developing economies we continue to use a spread of funds, covering the Pacific region, China and India. These are a must for long-term investment, but, until prices in China and India cool down, we would favour general Pacific funds which provides exposure to Japan, finally likely to provide growth after many years repairing itself from the very substantial bubble in the Japanese market in the 1980’s and also exposure to Australia. The Pacific Fund also gives exposure to other markets benefiting from Chinese and Indian demand such as Australia for commodities.

New – Middle East

This year we recommend adding investment in Middle East Equities where the principle play is on the fast growing Turkish economy and secondarily on Egypt and Israel, all of which remain within the Eurosphere, i.e. where Europe is the principle trading partner.

New – Alternative Energy

In the long-term, the strongest area for growth is likely to be alternative energy. This is being driven not just by substantial inflows of venture capital monies, private bank investment, etc., but also led in particular by Europe, but now also by the US and by China in the form of legislative direction for energy efficiency and alternative energy generation. Although the retail fund market is embryonic funds have recently opened which will provide you with vital exposure to this expansive theme.

In order to avoid over-concentration on any one sub-sector we recommend a mix of funds that investment in alternative energy, in water and the global natural resources.

Alternative energy is largely dominated by wind, solar and bio-fuel companies, all of which are experiencing strong growth. Investing in water utilities, which bring increasingly scarce fresh water in important countries throughout the world, especially in Europe, has also being a very strong growth sector and is earmarked for continued growth uncorrelated to equity markets into the future. Global natural resources means investing principally across oil and gas majors, gold and metal mining companies and in food. This year the soft commodities, i.e. food related, is likely to see the strongest growth in prices. But commodity prices, in general, are highly volatile and patience is needed to weather the inherent ups and downs.

Mixing investment in energy/power and commodities in this way is highly recommended as a core investment in balance sheets, rather than something on the periphery. It provides vital diversification from conventional assets.

CONCLUSION

Nobody can predict what will happen and, as ever, the only way you can protect your balance sheet while continuing to give yourself some exposure towards growth over the long-term is to ensure that it is diversified into an uncorrelated mix of assets, which you hold through thick and thin. Investors seeking income support and modest growth should continue to remain cautious and avoid over-concentration in strong growth sectors, favouring lower risk assets instead.

Should you wish to direct money towards any of the above investments over the course of 2008, please send us an email. In the meantime, may I take this opportunity on behalf of the FDM Limited team to wish you and yours a happy and prosperous 2008.

Eddie Hobbs