Market Musings 300623:
Differing attitudes to Risk-Taking

Stock markets ignores European economic erosion

Summary:

• Getting wealthy v staying wealthy

• Why I am still not rushing to buy UK property yet

• What interests me this week: surprising resilience of the Euro STOXX 50 index

Podcast: Does money make people happy?

In this podcast, Edmund Shing shares his thoughts about the correlation (or lack of) between money and happiness.

• What is happiness, and can it be measured?

• Which countries have the highest average scores of life satisfaction?

• Are wealthy people happier than those who are not?

• Do you have to earn a lot to be happy?

Different mentalities: Getting v Staying Wealthy

In my everyday work, I come across a great number of wealthy and very wealthy individuals and families.

When we look at the origins of this wealth, it is sometimes inherited and has occasionally been passed down through generations of the same family.

But more often, it has been built up by an entrepreneur or someone who has risen to or close to the top in a big, successful company and has built their wealth over years.

Entrepreneurs are risk takers by nature: In the case of entrepreneurs and company founders, they have usually had to take great personal and financial risks in order to get their businesses off the ground, combined with huge determination and an awful lot of hard work.

So to become a successful founder and business owner, one generally takes great business and financial risks. So successful entrepreneurs tend to be by nature risk-takers, or else they would never have embarked on such a perilous business journey in the first place.

I can see this in a small way with my own parents, who arrived in the UK in the 1960s from overseas with little to their name and no further education qualifications, but steadily worked hard and built up a series of businesses in the catering industry (restaurant, bar, cafe hotel) over years in order to build up their current comfortable financial state.

Initially, they had to build up their savings by working very hard including overtime in order to open their own small restaurant, of course borrowing money from the bank to supplement their own starting capital.

Being your own boss may give you a sense of freedom to determine your own destiny, but it comes with all the pressures of running a business including managing staff, and making sure to cover all costs and turn a profit.

Starting a new business is statistically very risky: In the UK, according to research by Fundsquire, a global start up funding network, 20% of small businesses fail in their first year. Around 60% of small businesses fail within the first three years.

Bottom line: successful entrepreneurs need to take relatively high levels of risk, they need to be prepared to work extremely hard and to remain determined in the face of difficulties that may arise.

Staying Wealthy = Conservative investing approach

In contrast, when these founders want to be able to dial back their involvement in their successful business or even sell the business and retire, and perhaps also to pass on their accumulated wealth eventually to their family or others, a different mindset is required.

Here the objective is the preservation of wealth, rather than the rapid accumulation of wealth via business success. In this case, wealthy people tend to adopt a far more conservative attitude to investing their accumulated financial assets.

This reminds me of the old joke:

“Q: What is the easiest way to become a millionaire?

A: Start by being a billionaire.”

History is littered with examples of multi-billionaires who have seen their accumulated wealth evaporate in front of their eyes due to over-concentration of investment in a single company (usually the one they majority own or founded) and the dangers of debt (the effects of so-called over-leverage).

Hence, the approach to staying wealthy once this level is achieved (whatever your personal definition is), is much more about diversification and a conservative approach to investment in order to minimise the risk of such a catastrophic drawdown in accumulated wealth.

I was unsurprised when reading the recently-published Capgemini World Wealth Report 2023 to note that 34% of the investment portfolios of High Net Worth Individuals (HNWIs, generally with a financial asset portfolio of at least $5 million) was held in cash and cash-like investments at the end of 2022.

Given the sharp falls in both stock and bond markets over the majority of 2022, these HNWIs have rotated back into cash, which has become more attractive as a risk-free asset class given the higher interest rates on offer in bank deposit accounts and money market funds in US dollars, euros or pounds sterling.

Asset price falls not over yet: delayed reaction in real estate

While stock and bond markets have in general rebounded since October 2022, the biggest asset class globally continues to suffer - property. The largest financial exposure of most households is to residential property (both one’s own home plus rental properties), while commercial real estate (offices, warehouses, retail stores and other) is also a substantial proportion of the investment portfolios of wealthy individuals, either directly held or via property funds.

Higher interest rates weigh: Both residential and commercial property markets continue to suffer sustained falls, as the effect of higher short- and long-term interest rates and thus mortgage rates continues to weigh on demand for both classes of property.

Lags in property price falls: As always, property prices take a lot longer to adjust than stocks or bonds, as there is always a “stand-off” between sellers who don’t want to accept significantly lower prices for their properties, and buyers who want a larger discount to listed prices given the tougher economic conditions and more expensive financing costs.

This typically means that property prices react with a 6-12 month lag to the downside when interest rates go up and economic conditions deteriorate, compared to listed stocks, bonds and listed property funds (Real Estate Investment Trusts, or REITs).

Of course, investments in property are always long-term commitments given the lack of liquidity, the high transaction costs (including estate agent and solicitors’ fees, and taxes) and the difficulty of buying and selling which can take weeks or months to complete.

As a result, even as stock and bond markets recover from the sharp falls suffered last year, property markets continue to see selling pressure as mortgage rates continue to climb.

Why I am not buying a UK property yet

Here is a great chart from Duncan Lamont of Schroders on UK housing affordability (calculated as the average house price divided by average yearly earnings):

UK housing is expensive by historical standards: As you can clearly see, this house price multiple has gone up sharply since the early 1990s, with the average multiple more than doubling over this time from just over 4x average yearly earnings then to 9x by November last year.

Sure, this multiple will have eased a little since then: for last month, the Nationwide has reported a year-on-year fall in the average UK house price of 3.6% while average earnings are increasing thanks to higher wage inflation.

However note the starting point - a house price multiple that is higher than at any time in the 20th or 21st centuries!

Here is a history of the average UK interest rate from the year 2000:

Note how the very low UK interest rate from the end of 2009 fuelled the steady rise in average house prices until early 2022.

More rate hikes to come: Note that the Bank of England has been very clear here: they will have to raise interest rates further in the coming months, given the stickiness of UK inflation. This looks likely to provoke an economic recession in the UK, generally not good news for the property market if the unemployment rate rises as a result of falling growth.

Many homes owned outright today: The relatively good news for the UK housing market is that in most areas outside of London and the South East of England, the majority of homes are owned outright with no outstanding mortgage - so the impact of higher mortgage rates will be heavier in the more expensive regional housing markets where homeowners have higher outstanding mortgages.

Mortgages tend to be fixed not variable Secondly, due to the prevalence of 2- to 5-year fixed rate mortgages today as opposed to variable-rate mortgages, the pain for mortgage holders is delayed until the period of the fixed rate runs out and homeowners need to remortgage, at a new far higher interest rate.

For these reasons, I suspect that UK house prices can ease their way lower over the coming months - but I don’t expect any dramatic moves given the current resilience of the employment market and the relatively steady pace of fixed-rate mortgage expiries and resets.

Bottom line: no reason to rush in yet!

What interests me this week:
Can Europe break out to New Highs?

Despite the poor economic momentum in the Eurozone at present, the benchmark Euro STOXX 50 index of the 50 leading stocks in the Eurozone has returned to its multi-year highs.

This can be accessed even in pound terms via the CS51 iShares Core Euro STOXX 50 UCITS ETF.

Could it mimic the recent performance of the Japanese Nikkei 225 and break out to form a new high?

Frankly, given the pretty dreadful economic momentum in France, Germany and other Eurozone countries in June, I am surprised that European stocks are so resilient. But the best traders all say that one should listen to market action…

Source: tradingview.com

In terms of index composition, it is surprising to see that the biggest sectors in the Euro STOXX 50 making up 50% of the index today are:

• Consumer Discretionary, i.e. luxury goods + cosmetics (LVMH, L’Oreal);

• Technology (ASML, SAP);

• Industrlals (Siemens, Schneider Electric)

Yes, Financials (Banks, Insurance, Other Financials) represent over 18% of the Euro STOXX 50, but this is far lower than in previous years.

I am personally watching the key Banks sector for clues of whether this positive momentum can be sustained, given the economic sensitivity of Banks in terms of loan demand and the potential increase in bad debts from economic deterioration…

Source: tradingview.com

Bonne chance,

Edmund