Posts Tagged ‘Investment’

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It is kind of assumed that savings are good, debt is bad. If that is so, then there has been good news from the EU and bad news from the UK. In the EU savings ratios are rising, according to recent data, while in the UK they are falling. So that is EU good, UK bad. It is just that the real story is quite different, because there is something missing, and that missing ingredient is called investment.

Across the global economy savings equal investment. They have to; it is a matter of definition. GDP equals consumption plus exports, minus imports, government spending and investment. But across the global economy exports must equal imports. Drill down and look at government spending and actually it is one of two things: consumption or investment. So GDP really equals consumption plus investment.

But what are savings? By definition they are income that is earned but not spent on consumption. So by definition, savings equal investment.

But supposing we all decide we want to save more, and we all park more of our earnings in our savings account. Supposing there is no corresponding rise in investment. If this were to happen, given the equation that GDP equals consumption and investment, then either as we save more, other people borrow more, or the money we save is lost forever.

To put it another way, across the economy there is no point in saving unless this is matched by investment.

Now take the EU. According to data yesterday (30 July) in the EU27, the household saving rate was 11.0 per cent, compared with 10.7 per cent in the previous quarter. In contrast the household investment rate was 7.9 per cent in the first quarter of 2013, compared with 8.1 per cent in the fourth quarter of 2012.

Now take the euro area. In the first quarter of 2013, the household saving rate was 13.1 per cent, compared with 12.4 per cent in the fourth quarter of 2012. The household investment rate was 8.4 per cent, compared with 8.7 per cent in the previous quarter.

In short, savings ratios are rising, but investment ratios are not. This is not merely a negative development, it borders on being disastrous.

In contrast, the household savings ratio in the UK was 4.2 per cent in Q1 2013, the weakest since Q1 2009 when it was 3.4 per cent. The UK savings ratio is too low, but what really matters is not savings, it is investment.

In the UK investment remains way too low, but here is some rare good news. 2013 looks to be on course for seeing the highest levels of investment in the UK since before the crisis of 2008.

© Investment & Business News 2013

If UK consumers open their wallets and purses and start spending in any significant way soon something is wrong. But there are reasons to think that exporters and investment may lead the UK forward. This is where we enter a danger period. A recovery built on correcting imbalances will be a good thing. But recovery built on consumer debt, as rising house prices encourage them to go out and buy, would be most worrisome and may even give credence to the prophets of doom.

The truth is that growth in UK wages has been lagging behind inflation since the beginning of 2010. Savings have been much higher too. In the second quarter of 2008, the UK was entering recession, but at that point economic forecasters had not woken up to this, and many were still forecasting a mild slow down. During this quarter the UK savings ratio was just 0.2 per cent.

This was surely evidence we had entered a time of madness. But a year later, the savings ratio had risen to 8.6 per cent. That was a staggering rise. UK households, scared by the prospect of falling house prices, had hit a big red button with the legend danger emblazoned on it. They saved more, and soon after, their wages fell.

So what do you get when consumers spend a lower proportion of their wages, while wages relative to inflation fall? Answer: a very severe dip in spending. No wonder the recession was so severe.

But the solution to this problem is surely not to encourage households to save less and borrow more. It is to try to get wages to rise, and for business and the government to use the money that households are saving to fund investment. At the same time, UK company profits are surging, and corporate cash sitting in deposit accounts at UK banks has hit 25 per cent of GDP, which is a 25 year high.

The UK can go one of two ways. The money that is not being spent, and is instead sloshing around the banking system, could be used to fund mortgages and in turn create a housing boom. Writing in the ‘Telegraph’ recently, Jeremy Warner said: “UK housing was not the cause of the financial crisis; in fact, UK mortgage lending has remained a haven of calm and safety for the banks throughout the storm.” See: Unbalanced and unsustainable – this is the wrong kind of growth

Maybe he is right, but isn’t that the problem. For too long, whatever money that is available has been used to fund mortgages, even buy-to-let mortgages because they are seen as safe, instead of funding entrepreneurs and wider investment because this is seen as risky. Even many would-be entrepreneurs have been seduced by the allure of easy and low risk money from buy-to-let, and have left the path of wealth creation and joined the path of re-shuffling wealth, which is all that buy-to-let achieves.

If the UK goes down the path of creating a housing boom, the causality may be true entrepreneurism and a boom based on debt rather than productivity. Alternatively, if savings were used instead to fund investment, the result would be truly exciting.

Despite George Osborne’s efforts to administer the first of the alternatives – the cheap and easy way to growth, election victory and an unsustainable economy in which falling government debt is paid for by rising household debt – there are signs that the second approach is occurring anyway.

The UK’s export recovery has been held back by the rather unfortunate fact that the Eurozone, our largest trading partner, is in the midst of an economic depression. But since 2002 exports to China have risen sevenfold. According to a report published by the ONS a few days ago: “In the latest three months the value of exports was 17 per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the latest three months.”

Just as is the case in the US, there are also signs of manufacturing led recovery. UK car exports are beginning to outstrip imports. There is also anecdotal evidence of companies returning their manufacturing to the UK. As Capital Economics said: “The decline in offshoring has reflected a variety of factors. For a start, the trend towards more capital intensive production as technology improves means that the savings in labour costs that can be achieved by switching production to Asia have become a smaller component of total costs.

Western manufacturers are also increasingly specialising in high-tech sectors in which production cannot necessarily be replicated elsewhere. The strengthening of Asian currencies has also reduced the savings from offshoring. In addition, fast supply chains are increasingly valued, so that production can respond quickly to consumer tastes and inventory costs can be reduced. “

As for the UK, it said: “According to the manufacturers’ organisation EEF, the proportion of firms repatriating some output rose from 15 per cent in 2009 to 40 per cent last year.” It continued: “Low-value sectors such as textiles have been declining, while high-value markets such as pharmaceuticals and transport have been growing rapidly. The destination of UK manufacturing exports has also evolved. The share of goods exports going to the fast-growing BRIC economies increased from 5 per cent in 2007 to 8 per cent last year and has also persuaded some firms to produce domestically.”

There other reasons to be optimistic. Demographics are looking favourable. Population growth in the UK in this decade is likely to be at its fastest rate since the first decade of the 20th century. The shortage of homes to population is a problem, but there are signs this may be fixed as the government tries to reform planning laws. A house price bubble will do little for the UK in the long term, but a house building boom is different thing altogether, and this may happen.

North Sea oil output is on the rise again, and the shale gas revolution may or may not be a mixed blessing, but it should at least help to promote growth. And don’t forget that in a growing global economy the UK has certain innate advantages: its time zone being one. The UK working day overlaps with working days in both California and East Asia. The fact that English is spoken rather widely in the UK is another advantage. Add to that political stability and a strong legal system.

Yet, for all that optimism, something broken remains. The UK is not well disposed to encouraging risky investment. That may not sound like such a bad thing, but remember that risk is the key to innovation and growth in the long run.

The government can do more to help and it could start by using money created by the Bank of England via QE to directly fund investment into infrastructure and in entrepreneurs.

© Investment & Business News 2013

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The latest news out of the US really was good. But one question remains: is the US engaged in some kind of Ponzi Scheme or is the recovery real?

Here is the idea: you borrow, say, £100 off one set of people, and £200 off another set. You use the £200 loan to repay the first set, giving them, say, £130 back.

So happy are these people with their profit, that when you go back to them asking for a £400 loan they gladly oblige. You can then use the £400 loan to repay the £200 loan and provide a nice profit for the backers too. You can carry on like that right up to the moment when you run out of places to go to raise money.

That’s what Bernard Madoff did; it is what Charles Ponzi did in the 1920s. And it is what we call a Ponzi Scheme.

The question is, however, whether the word Ponzi Scheme applies to the US economy. The answer may surprise you.

US consumer confidence, as measured by the Conference Board, rose to 76.2 in May, which was the highest reading since January 2008. It may be the strongest evidence yet that the US economy is on the road to recovery.

However, it might be worth asking why? US stocks are up, as are US house prices, which makes US consumers feel a good deal happier. In the US, stock market performance is more closely correlated with consumer confidence than in the UK, where our obsession with house prices is all pervasive.

But why are US stocks up? At least one of the reasons given for some of the rises seen in recent months is that US consumer confidence has improved. Do you see why there is a slight Ponzi Scheme feel about it all?

There is another reason for buoyant stock prices, however, and that reason is QE. So the Fed buys bonds, forcing their price up. Other assets seem cheap in comparison, so they rise in price, and thus US consumers feel more confident. If you think this has a whiff of Ponzi Scheme, you are not alone.

It is just that when we look at the macro economy things are different. When consumers are more confident, they spend more, and when they spend more, companies sell more stuff, wages rise, investment goes up, and maybe we see more innovation as a result of this. This drives up stock prices and in turn US consumer confidence. Yes it is like a Ponzi Scheme, but the difference is that it can create real wealth.

Maybe all growth we have seen over the last two hundred years is built on a Ponzi Scheme, but on this occasion it is as if snake oil has turned into nectar.

© Investment & Business News 2013

It was the best year since the heady day of the mid-noughties for the venture capital business. At least it was the best year for Venture Capital Trusts (VCTS), which is not necessarily the same thing, although it should be a pretty good guide.

According to the Association of Investment Companies – or AIC if you are in a hurry – the VCT sector raised £402.5m in the 2012/13 tax year.

This compares with £331 million in the previous year, and as little as £158 million in 2009/09. In the year 2005/06, however, the sector raised £779 million, which was its record year. It also did better in 2005/05 and 2000/01.

The year 2003/04 was the worst recorded, (stats go back to 1995/96), when just £50 million was raised.

From an investor’s point of view there are strong tax benefits in investing into VCTs. Of course these days, tax avoidance is considered a bit fly, a bit immoral. But this does not apply to investing in VCTs; the government wants investors to pile their money into this sector.

Actually, this is the kind of news that UK plc needs. In all the criticisms aimed at banks, it is forgotten that truly innovative companies don’t need bank loans. They need investors, who take equity and a share in future profits, rather than charge a fixed interest rate, which is the same regardless of how successful the recipient of the investment is.

Think of it this way. When it comes to measuring the success of innovative companies, say ten years after inception, the curve representing success does not follow a normal distribution pattern. Rather a small number of companies – the likes of Google and Facebook – make it really big, but many others fail altogether. A banking model applying debt is manifestly not the right model for such a scenario.

Just remember, however, that smaller companies and real start-ups are too small to interest the VCTs.

For the UK it is good news that the VCT sector seems to be growing in popularity again. The UK also needs another investment level, relevant to companies that fall outside the VCT radar.

You may or may not think Twitter and Facebook are worth your investment bucks, pennies and cents, but it does appear that investors plugged into certain social media services often enjoy better returns.

Gillian Tett at the ‘FT’ broke the story, but actually, it should not come as a surprise. Ms Tett focused on the work of two MIT academics: Sandy Pentland and Yaniv Altshuler. After analysing a mountain of data, they found that investors who are plugged into a diverse range of investment groups enjoy the better returns.

They found that investors who work on their own often perform least well. Those who follow one or two investment gurus do better, but not as well as those who follow several such gurus. But the best performing group are those that just follow a diverse and large range of other investors covering a wide range of specialities and interests.

Pentland and Altshuler focused on a trading platform called eToro. The service itself describes itself in these terms: “Social Trading is about opening the markets to everyone. At eToro we encourage people to connect with one another to discuss, trade, invest, learn and share knowledge across the network. From now on, you don’t need to be a pro to trade like one.”

But this is not the first research of this ilk. Last year Johan Bollen and Huina Mao of Indiana University and Xiao-Jun Zeng of the University of Manchester found that investors who tap into the public mood often enjoy superior performances. They also found that Twitter is a good gauge of such mood. See: Can Twitter predict the stock market? 

Fashion: it is not a concept many investors like to admit to, particularly those who suggest that investment is a science, but truth be told stocks rise and fall with fashion. Sometimes shares rise because the crowd has decided they are going to. On the back of crowd behaviour we got the dotcom bubble, gold rising and falling and bitcoins – for example.

There is a flaw with the idea of wisdom of crowds. Studies show that crowds can be very smart, BUT when and only when the individuals who make up the crowd work in isolation. The classic study was carried out by Francis Galton in 1906, when he surveyed visitors who entered a competition for guessing the weight of an ox at a livestock fair. Galton found that the average guess was very accurate, and so the concept of the wisdom of the crowd was born.

But the crowd in the Galton study had one characteristic that we rarely see in practice. Each guess was made in isolation and was not subjected to the influences of what others thought. Psychological studies provide overwhelming evidence that we all tend to comply with the crowd.

Ten million.

How tall do you think the author of this article is? Take a guess, go on.

Studies show that if the number ‘ten million’ quoted above had been lower, say four, instead of ten million, your guess as to the writer’s height would have been much lower. It sounds ridiculous, but it is true.

That is the point; we are all influenced by each other in surprising and often quite unintuitive ways.

If you can gauge the mood of the crowd, you would indeed have an advantage in predicting stock market changes. By plugging into social media we become a part of the crowd, but maybe we can understand it better too.

There is a snag. Crowds can get it horrendously wrong. The individuals who make up a crowd copy each other. But there is always a limit. A crowd can persuade itself to back an idea beyond that point when its support is rational.

By plugging into the crowd you may be able to second guess fashion in investment, but you may also get swept along, and when the bubble bursts you will find little comfort in the fact that you share one thing in common with the crowd – a lost fortune.