Economic Newsletter dated January 2009

Before we discuss the economic situation, we are proud to announce that AisaProfessional was considered by Money Marketing to be in the top 10 of advisers in the UK for both Best Investment Adviser & Best Retirement Planner 2009. This was undoubtedly due to our commitment to continuous improvement for our clients, and the way in which we have embraced technology, websites and the constructive method we communicate with our clients.

The views in this letter represent the opinions of Aisa and should not be construed as a statement of fact. Further advice should be sought before actioning any investment or tax advice. The Financial Services Authority does not regulate opinions on the economic outlook, nor does it regulate some forms of tax advice or comment.

Outline

Between 2005-2007, at our seminars, we highlighted the risk to our economy of government overspending during a boom and of the inevitable property downturn. In late 2007 we saw the start of the credit crisis, leading to a lack of credit available in 2008, asset prices dropping and bank liquidity issues; one of the main contributors to what looks like developing in to a severe recession in the UK is the contraction of lending by our banks. All asset classes have been affected and, whilst property will be one of the worst affected LONG TERM asset classes, short term issues (3 years) will see many companies, banks and economies in severe distress. You already see big names like Woolworths, Zavvi and Wedgewood going into administration. In October 2008 we witnessed the failure of major banking institutions, an economy, and by all accounts, we were literally hours away from the banking system completely collapsing. So what can we look forward to in 2009?

Economic Outlook

First of all, 2008 has to go down as the worst year for investments in living memory. Every single asset class has reduced in value and finally, the public has understood that cash does have several risks. Cash has suddenly, and spectacularly, lost completely its ‘no risk’ status!

It has also now become apparent that the last fifteen years has been a huge bubble fuelled by debt and that to correct this situation, a reduction in the overall quantity of debt in the economy is absolutely necessary. Further it would appear that some of this debt is linked to assets that no longer have any value, and some debt has been classed as ‘toxic’. On the 30th November 2007, the Council of Mortgage Lenders (CML) warned that “funding pressures have started to crystallize for a number of lenders” and they were issuing a plea to the Bank of England (BoE) to reduce rates. That has happened of course, and as of yesterday, we are now at 1.5%, the lowest level ever recorded in over three hundred years!

The Chief Executive of Barclays, John Varley, said to the BBC in December 2007, “I think that we will see the process of reduced borrowing play out over at least the course of the next twelve months maybe, maybe twenty four months. I think it's important to say though that the industry is open for business…...”

The problem is that we are still only at the beginning of the re-balancing of asset prices that has to take place. For example, ‘Hedge Funds’ that were highly geared (they borrowed a lot) will continue to be forced to sell assets to meet liquidity demands (cash) to repay their borrowings. This continuous repayment of debt will most likely take years rather than months, for individuals, companies and the government.

What is clear is that economists are unable to provide a clear consistent prediction of what is going to happen in 2009 and 2010. All their theoretical models are broken! It somewhat brings into question why we seek their opinion as they only seem sure, until they are no longer sure, and then they re-write their formulae again!

The main story here is the continuing ‘credit squeeze ’ and it will continue to effect our economies for years. Inevitably, it will lead to a reduction in asset prices down to a pre-credit boom realistically affordable level, an overall contraction of economies and to a structural change in the UK economy. The banks need to recapitalise and while they do, lending will have to prudent and reduce. We have discovered that lending inexorably is linked to asset prices; the two are likely to go and down together! Moreover, at the very time that this recapitalisation is taking place, banks balance sheets are being further depleted by the cost of the providing the guarantees for cash deposits.

When talking to people, it is becoming clear that most believe that the guarantees on their cash have no cost implications. This is simply not true! This is costing the banks and to reclaim this, the banks are lending less and putting charges up, keeping the cost of lending high and paying lower interest rates on savings accounts. We are ultimately paying for the guarantees on our own cash!

The global economic pressures are too vast for any one country to stem the inevitable difficulties that we will all face. The lack of available credit continues to affect all of the five main asset groups. Thus, Commodities, Equities, Property, Fixed interest and Cash, are all being affected.

Commodities

At the end of 2007 we recommended that investors consider commodity based funds or direct commodities. We got it right until August 2008 and then the biggest reversal ever seen occurred. So rapid was the reversal that the best example we can give is that of oil. In July it was hitting record highs and motorists were almost going on self-enforced rationing. Now, in January 5 months later, the price of oil is now the lowest in years and prices at the pumps is some regions are lower than 2 years ago. Wow!

However, the reason behind the rapid reversal was the same as all other asset classes – the rapid recession that in all but name is global, that the economists and OECD completely missed.

Commodities in the long term still seems a good investment but you may well have to wait for 18 months until the beginning of recovery is seen not just in the UK, but globally (if it happens that fast!).

Equities

We are reviewing our asset allocation models currently and also reviewing the way in which we ask risk questions. The key is going to be a more specific approach to investing in certain sectors, and avoiding others. The fact remains that some sectors and geographical areas have shown shocking performance, like China (minus 65%) as a whole or the banking sector. Not all equities have performed this badly and stock picking is going to be all important in 2009 and 2010. We are not attempting to invest large amounts of new client money into equities currently but we are still investing a small proportion for those prepared to take the normal risk of equities.

For those people who have remaining invested in equities with a long term view, then just like in the year 2000, it is best to now ride out the continued turbulence unless you have some key reason why you require access to the money now. We have been avoiding selling at the lows since the Banking crisis in October and already people have benefited in the last 2 months. Therefore, diversification across markets, sectors and worldwide shares is a must. We have sympathy with those that invested in 2007 or early 2008 that are seeing a loss, but this was on the tail of a very good rally over the last few years, and this rally will happen again, we just do not know exactly when. Depending on what policy decisions the UK and other governments take will determine when. We are hopeful that by the end of 2009, we will see the start.

Cash

Icelandic banks sum the issues up with cash. There is little confidence left in the market and with interest rates so low (many less than 1% and some at zero!), savers are now being penalised. On television last night were a group of pensioners saying that their lifelong prudence is being thrown away because of reckless lending and borrowing by governments, companies and individuals. Quite true! The prudent are paying for the reckless. With assets falling so much however, those with cash will be able to find some real bargains in 2009.

The only value of cash at this time is safety, and even then an investor has to be very careful with which organisation and how much they are investing. We have put together tables and are providing fee based advice on this for those who seek our knowledge.

Property

Reckless lending and borrowing is taking its toll with this asset class, which we anticipate will ultimately be severe.

Residential

We correctly predicted last year that property would go down substantially, by around 10%. We were out on a limb 12 months ago and you must remember at that point many economists and reporters were predicting stagnation only.

With the undoubtedly difficult lending markets we really cannot see any recovery in the market and with lending down and unemployment increasing, our inevitable conclusion is a further hefty decrease in property values in 2009 and probably 2010 as well. A double digit annual decrease was not even experienced in the two previous housing ‘crashes’, and so it is now officially a very heavy fall.

Interestingly in the last 2 weeks, major lenders and RICS have stopped publishing expectations (they have never done this before). In other words they do not want to predict heavy falls as it exacerbates the problem!

So, we do not know what they think officially, and is very hard to assess how far they will fall, but we stick with our original 2007 claim that property overall is likely to go down between 30-40% from the peaks seen in that year.

Commercial

WWe have already seen substantial 25-30% falls in commercial property and in August we thought there would be a slight recovery in 2009. With October 2008, we changed our minds. With the recent major problems with high street retailers and the down turn in manufacturing there is only one inevitable direction for commercial property. This downward trend will continue throughout 2009.

Fixed Interest

Fixed Interest has also fallen substantially. However, rather than concentrate on the negatives, this is one area of investment that we feel happy to recommend. Why? Well, part of the reason for the substantial decrease has been defaults and in some cases fraud, and also there should be a combined effect of reducing government bond yields and, more recently, narrowing credit spreads (from very wide spreads in 2008).

Corporate failures in excess of those during the 1930’s depression have been priced in to fixed interest securities. We are talking in the region of twenty to forty percent failures and means that the yields have increased substantially. This default rate is incredibly high and so the anticipation already shown by fund managers should mean that as 2009 progresses there should be some re-assessment of this default rate, and hopefully it will be upwards! Though it cannot be guaranteed of course. Better rated investment grade bonds look more attractive, having already suffered significant capital losses over the last 12-24 months.

Conclusion

We are in a volatile economic situation that we expect to last another twelve to eighteen months at least yet, with all the asset classes continuing to be affected, from cash to equities. To combat this volatility, spreading your assets is the proven way to work, and stock and sector selection is more important than ever before.

Last year we wrote that we thought that those of you purely in Equities or Property at the moment are going to suffer increased volatility, possible high risks, and you needed to speak with us then. Some people did and others did not. This time we suggest you ring us now! Remember that we combine our advice with the latest in tax planning, to prevent you losing more money to the taxman than you should.

AisaProfessional advisers; providing high quality advice to benefit you!

James Pearcy-Caldwell -- Director

Notes …

Please note that the opinions expressed in this letter must not be construed as statements of fact – you should carry out your own further research before coming to a decision and before taking any action.

The views in this letter represent the opinions of Aisa and should not be construed as a statement of fact. Further advice should be sought before actioning any investment or tax advice. The Financial Services Authority does not regulate opinions on the economic outlook, nor does it regulate some forms of tax advice or comment such as this.

Dated 9 January 2009 – valid for 12 months. Aisa Direct Ltd, authorised and regulated by the FSA as Independent Financial Advisers. 1 Fordbrook Business Centre, Pewsey, SN9 5NU

* This newsletter has been prepared with all possible care to ensure its accuracy. It is based on our current understanding of legislation and HMRC practice. 

* Neither Aisa Direct Ltd nor any of its employees can accept responsibility for any errors or omissions. You should seek further professional advice prior to action.