The Fiscal Cliff and Severe Real S&P500 Bear Markets – January 2013 Update

With the US Government this week deciding that it was going to make no attempt to at least start the country along the road towards living within its means, the so called Fiscal Cliff was avoided.  In response the S&P500 rose 4.0% in the week to close at 1,466.  While the main stream media were getting all excited about this increase I started to think about how this continual kicking of the can down the road could actually be storing up future problems, which might actually prolong the Severe Real S&P500 Bear Market I believe we may still find ourselves within.  I last posted about this analysis in September 2012.  As a reminder I define a Severe S&P500 Bear Market as a period in time where from the stock market reaching a new Real (inflation adjusted) high it then proceeded to lose in excess of 60% of its real Value.

The previous Severe Real S&P500 Bear Markets are revealed in the chart below which corrects historic S&P500 Prices since 1881 by the devaluation of the US Dollar to arrive at Real Prices.  This chart shows we are now back to Prices last seen in March 1998 and also shows we have seen three previous Severe Real Bear Markets.    

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If I think of the US Government putting off this unpopular decision for another day then at some time in the future the bond market may force them to make a decision.  Of course at that time they will then have somebody else to blame which will suit the weak politicians whose only focus seems to be to get themselves re-elected.  The subsequent rise in taxes and cuts to spending which would then follow would then have to be worse than they were faced with today because through indecision they have made the problem a larger one to solve. The S&P 500 may then respond with a big fall which brings me back to the chart above.  Now there is of course a risk that I’ve been looking at this chart too long however I can generally see in the last 3 Severe Bear Markets two lower Real highs following the initial new Real high.  From this second lower Real high we then see Real Prices fall between 40 and 60%.  Are we are nearing that second lower high and could this government indecision actually end up causing this next big leg down?  Of course I would never buy or sell based on this hypothesis because the market can remain irrational far longer than I can remain solvent.

If I overlay the three Severe S&P Bear Markets with today’s market by comparing the percentage change in value from the peak for each of these periods we arrive at today’s second chart.  So what were these previous bear markets?

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Investing for Income via Investment Trusts

I’m very pleased to introduce a post from Retirement Investing Today reader John Hulton. John claims to not be a financial guru, stockbroker or financial journalist, but just an average bloke who has managed to find a way through the minefields of personal finance, develop a system that works for him and which could be helpful for other people. He has already retired from full time work at the age of 55 and as he is now financially secure can afford to relax, spend more time pursuing his hobbies, managing his investments and pension. Or in short a perfect match for what this website is all about.  I hope you enjoy his thoughts.

In my ebook Slow & Steady Steps from Debt to Wealth I set out a step-by-step guide to generating income from the stockmarket. I have found, through a process of trial and error over several years, that a combination of individual higher yield shares together with a portfolio of investment trusts gets the job done for me.

In this post I will outline some of the benefits of investment trusts and at a later date, return to my shares portfolio.

I currently hold a core portfolio of 12 trusts which have been gradually built up over the past few years. They have been mainly purchased during periods of market downturns. The most recent buying spree was May 2012 when I purchased Invesco Income, Edinburgh, Temple Bar, Aberforth Smaller and topped up City of London and Murray International.

The mainstay of my portfolio is selected from the UK Income & Growth sector, however I like a well diversified range of investment trusts and include international orientated trusts as well as smaller companies and corporate bonds. Average return this past year including dividends was 21%. The column headed ‘Revenue Reserves’ gives some indication of the number of months the trust could continue to pay dividends even if the trust received no further income.

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Bearing in mind the total return from the FTSE 100 was around 10%, I am more than pleased with this year’s returns. Dividends have increased this year by an average of 5%. I suspect all managers are maintaining some degree of caution and therefore retaining income within the trusts as increases on my individual shares portfolio have increased around 11% this year. The main thing for me is whether the portfolio delivers sustainable dividend increases which are above inflation each year.

How to start a portfolio

As with any portfolio, your aims should be to get the right balance between risk and reward, to be clear about what you want to achieve and over what time span, and then to adopt the right approach when the portfolio is fully invested. Do lots of research around the trusts which are most likely to achieve your goals and, of course, take it slow & steady.

At the time of writing this article the FTSE has climbed above 6,000 (last seen in July 2011) and as you can see, the total return on my investment trusts have increased over 20% so I would certainly be a little more cautious if I were starting today. There may well be more favourable opportunities over the coming year when the markets turn down and yields improve.

Of course, over the longer term, market timing is not so important but it will obviously be a little disappointing to pile in with your lump sum and see the value of your portfolio drop 10% or even 20% over the next few months. In a rising market it is better to drip feed money into the market gradually. My online broker Sippdeal has the option of regular investing for just £1.50 per trade which means you can economically invest sums of say £250 per month whilst waiting for better opportunities down the line. You could easily use my portfolio above as a template portfolio of say £12,000 and as the basis for starting your research. A common theme with all 12 holdings is that they have excellent long term performance records relative to their benchmarks and, by and large, managers who have been in place for some time. For example, Job Curtis at City of London has been manager since 1991 (shortly after I started investing). The trust has a record of increasing dividends in each of the past 46 years.

There are many investment trusts which could just as well do the same job or better - these are the ones I have researched. I do not advocate lazily copying these trusts (however tempting) as it is an important step, in my opinion, to do your own research and take responsibility for your selections and decisions.

A good starting point of reference for research is The Association of Investment Companies and also Trustnet.

UK Savings Account Interest Rates – January 2013 Update

Since 2009 UK savers have seen big falls in the interest rates being paid by the top savings accounts.  For a short time there was a little light at the end of the tunnel however this looks to have likely been removed with the Government / Bank of England’s introduction of the Funding for Lending Scheme (FLS).

Money Saving Expert tells us that if you are in the market for an easy access savings account you can get a savings interest rate of 2.35% AER.  Forget to switch at the end of 12 months to the bank offering the highest interest rate at that time and that becomes 1.35%.  Back in June 2012 you could get 3.2% AER variable with Santander reducing to 0.5% after 12 months.  That’s a fall of 0.85% in only 6 months.

If you choose to go for a no nonsense easy access savings account (always my preferred option), again using Money Saving Expert, that interest rate today is 2.3% AER with West Bromwich Building Society (as long you have a balance over £1,000 and only make 1 withdrawal a year).  Back in June 2012 the best rate was 2.75% AER variable with Aldermore (again, as long you had a balance over £1,000).  That’s a fall of 0.45% in 6 months.

Why do I think the Funding for lending Scheme has caused at least some, if not all of this?  Banks can now get cheap loans directly from the Bank of England to fund Business and Mortgage loans.  The more they borrow from the Bank of England they cheaper those loans become.  Why then borrow from the average punter.  They don’t need us anymore.  Well at least for the next 18 months. 

What’s worse is that the easy access savings accounts detailed above are the best accounts out there.  My chart today shows what is happening to the average account. 

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UK Mortgage Interest Rates – January 2013 Update

Analysis shows that today the purchase of a UK house through a mortgage is affordable however at the same time UK house prices are not good value.  This appears to be a surreal situation which is brought about by the abnormally low mortgage interest rates that are currently on offer today.  It is now my belief that we won’t see fairly valued housing in the UK until mortgages rates return to some semblance of normality.  With that in mind I’m starting a new dataset focused entirely on UK mortgage rates which will enable us to watch the mortgage market.  This might give us a heads up on what might be about to happen to house prices.

The Bank of England publishes a number of datasets on this topic and I have picked 5 which cover the more common mortgage types available today.  They are the sterling monthly mortgage interest rate of UK monetary financial institutions (excluding Central Bank) covering:

• Standard Variable Rate (SVR) mortgages
• Lifetime Tracker mortgages
• 2, 3 and 5 Year Fixed Rate Mortgages with a 75% loan to value ratio (LTV)

A history of these mortgage rates can be seen in the chart below.

 

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A zoomed version of this mortgage chart is shown below.  I’ve also placed the announcement dates of some of the well known market manipulations that have been undertaken by the UK Government and Bank of England which have helped keep rates mortgage rates low.  These include a Bank of England Bank Rate of 0.5%, 4 tranches of Quantitative Easing and the Funding for Lending Scheme (FLS).  So what is happening to mortgage rates?  Standard Variable and Lifetime Trackers are getting more expensive and are up 0.01% and 0.04% month on month respectively.  Year on year they are up 0.22% and 0.38%.

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RIT Reader EBook Plug – Slow and Steady Steps from Debt to Wealth

A Retirement Investment Reader, John Edwards, yesterday kindly sent me a copy of his EBook Slow & Steady Steps from Debt to Wealth. It’s a very easy read and at a little over 7,000 words can be devoured for the first time with a cup of tea. That said, doing something with the common sense approach will certainly take a little more time... I’ve been on a similar journey to the one described and I’m now 5 years in and still learning.

I’m plugging it because there is lot of commonality with the message I try and promote on Retirement Investing Today. The difference is that I fear that I sometimes over complicate the problem where John lays out a series of steps that go from debt (this site doesn’t really cover debt and instead starts with someone possessing £0) to a healthy investment portfolio.

Let’s look briefly at each of the Chapters in turn:
1. Avoid Debt. One sentence rams it home – “The first step to financial freedom is to avoid debt in the first place”. I couldn’t agree more.

2. Over Consumption. We are encouraged to answer two questions – “Do I really need this?” and “Do I really want this?” I probably push this concept more than most people could tolerate but it’s one of the ways I can regularly save 60% of my earnings.

3. Start Saving. This was the starting point in my KISS Investing for Retirement post.

4. Pension. “I had a variety of pension pots ... none were performing all that well and one reason for this was the high charges being levied every year.” I also believe that it is critical to minimise those charges and have it as one of the fundamentals of my Low Charge Strategy. I don’t understand how people can be so blasé and just accept say a 1% charge without question. Given that a reasonably balanced portfolio might only on average return 4% after inflation you could be giving 25% of your return away. John also makes another good point with the statement people “often don’t fully appreciate how much they need to save”. My belief is that you are not going to reach true financial independence early by saving 10% a year.