The Wall of Worry
I started in the fund management world in 1981, a smart (well, lucky) career choice as it was the year in which the great bull markets in equities and bonds began as Ronald Reagan entered the White House and Federal Reserve boss Paul Volcker began taming the inflation devil that had destroyed financial markets in the 1970s. Throughout the decades I’ve heard the same old wives tales time and time again: don’t fight the tape, don’t fight the Fed, all turkeys fly in a gale, the trend is your friend, and, one of my favourites, markets climb a wall of worry, which neatly brings us to last year.
Investors spent most of 2019 worrying about trade wars, global recession, falling corporate earnings, Central Bank monetary policy, Trump and Brexit and piled into safe haven assets like government bonds and gold. How come then they also piled into stocks with bumper returns all round, even in the toxic UK? The wall of worry of course. Markets collapsed in the last quarter of 2018 but prices climbed from this low base because all the bad news was already priced in and then continued to rally when the bad news turned out to be not quite so bad after all. The strong returns last year were based on a sense of relief that things didn’t get worse rather than that they got a lot better. The sense in the markets now though, is that the clouds are lifting and ‘safe haven’ bond yields have started to tick back up. The most important price in the world, the yield on the 10-year US Treasury, has risen from 1.50% in late summer to 1.90% and several of the 10-year yields in Europe have clawed back into positive territory, though not the almighty German Bund. As for the pariah of world equity markets, the UK, the Boris Bounce led to a rally in both sterling and UK domestic stocks. So markets feel far happier this January though beware another of my favourite sayings (derived from being a lifelong Everton fan) ‘it’s the hope that kills you’.
Macro…The Brave Old World
Contrary to the despair at the beginning of last year, and the infamous ‘inverted yield curve’ indicator, rumours of the imminent death of the global economy proved to be exaggerated and 2019 was a year of slowing, though still steady, growth. Yep, we worried about the trade wars and yep, we worried about Brexit but global recession was avoided in 2019. Inflation is muted despite wage growth picking up whilst unemployment is at multi-decade lows in the major economies. Not too shabby really, and more of the same likely this year as the long, shallow economic cycle rumbles steadily on, underpinned by virtually zero cost money from the ever-supportive Central Banks. In retrospect, I could have written the last two sentences in virtually any January of the last decade. If ‘lower for longer’ was the narrative of the ‘tens’ it will probably be that of the ‘twenties’ too. I plagiarised the title by the way, from the boffins at Twenty Four asset management so thank you guys, no lawsuit, please.
The fall in inflationary expectations has been a key driver of the increasingly dovish stance of the Central Banks throughout 2019 and together with the muted outlook for growth implies that monetary policy will remain very accommodative this year with interest rates looking set for a long period ‘on hold’ in the major economies. The message from the Fed is that it would require inflation to be persistently higher for it to consider raising rates and this looks very unlikely. So why did the yield curve get it so wrong as a recession indicator? Probably because, unlike in the past, the US commercial banks with their strong balance sheets and fairly upbeat views on the economy paid no attention to it and so didn’t pull back on lending as they had done in the past.
On our side of the pond we have a couple of Central Bank new brooms, Andrew Bailey (ex-FCA but also ex-Deputy Governor) is back at the Bank of England and steely politico Christine Lagarde (ex-head of the IMF) in the hot seat at the ECB. We expect it to be a case of ‘meet the new boss, just like the old boss’ as The Who would say, with no rocking the boat and in Lagarde’s case the main aim will be to keep inflation falling any further. The ECB appointment was the more significant with Lagarde seen as a generally ‘market-friendly’ choice when the alternative could have been the old-school Bundesbank hardliner Jens Weidmann who has little truck with all this QE malarkey and Germany bailing out its profligate cousins in the South. When we have our next ‘Eurozone crisis’ though, will Lagarde, the consensus-building politician, be as effective as the market savvy investment banker Mario Draghi showed himself to be?
A lot, of course, hangs on the trade war. In a Presidential election year, it suits Trump for this to take a back seat, hence the ‘phase 1’ agreement in December. Next year could be more problematic. Trump is the great aggressor on tariffs (and everything else sadly!) but the trade war is actually a very popular policy with both parties so whomever it may be, the new President will want a more wide-ranging deal which covers the tricky areas of intellectual property theft and state subsidies of exports. Negotiations could be very fraught and tariffs may well be on the agenda again in 2021.
As always, thank you to Schroders Asset Management for the consensus economic forecasts
Markets…The Slope of Hope
Equity markets produced very strong returns last year, albeit benefitting from a ‘recovery bounce’ after the calamitous Q4 2018. The global economy chugs along, avoiding recession, the yield curve has normalised, Central Banks remain the market’s best friend, cash is not a valid asset class, a US/China trade deal has been struck and a big Tory majority means that the three years of Brexit purgatory are over and finally there is some certainty in UK politics. Steady growth, muted inflation and supportive Central Banks isn’t such a bad background after all, as the last decade has shown. Mount up the cavalry, the Roaring ‘20s here we come. Sadly though there is always a ‘but’ and if markets climb the wall of worry, they also fall down the slope of hope. Following cliché with cliché, ‘buy on the sound of the cannons, sell on the sound of the bugles’ or maybe ‘buy when sleeping, hold while creeping, sell while leaping’. You get the message. Markets are a discounting mechanism with a bit of fear and greed thrown in. On January 1st, 2019 the markets were in despair but had priced in all the bad news and ended up delivering bumper returns. This year they are perky and optimistic, hmm….think about that one.
So what could possibly go wrong? A reversal of US interest rate policy on the back of a renewed acceleration in growth, geopolitical trauma of which the contenders are legion, or our old friend unintended consequences. Valuations have become expensive again. Global earnings were meagre last year such that the gain in stock prices was driven by multiple expansion and it is impossible to overstate the role of monetary policy in driving last year’s mega stock market returns. However, earnings have bottomed with estimates for US growth being in the region of 10% (as usual!) this year and with Central Banks continuing to provide money at zero cost, then investors will keep buying the dips until there is a big shift in momentum and sentiment for whatever reason. We expect positive returns from markets this year, though probably only single-digit after last year’s bonanza with plenty of volatility along the way.
In keeping with my strict Catholic upbringing, I spent part of the last newsletter in the confessional box explaining why three factors in particular (a short duration fixed income position, a ‘home bias’ to UK equities, and growth stocks hugely outperforming value) were holding back the portfolios. Confession is obviously good for the soul, and the portfolios, because these factors reversed somewhat in the last quarter with bond yields backing up slightly, value and cyclical equities showing a bit of form and a Lazarus like recovery from sterling and domestic UK equities as Boris romped home. Phew.
Sorry, I’m going to have to whisper this….
…but Brexit isn’t done after all, despite what Boris may have us believe. In fact, it hasn’t even really started. All we have done is fire the starting gun on a devilishly difficult one-year transition process in which the UK needs to agree a monumentally long and complex deal with the EU to formalise the new relationship on trade, security, immigration, financial services, farming and fishery and a host of other issues. Apparently far less complex deals with other countries have taken between four and nine years so good luck with that! If no trade deal can be agreed then we are back in ‘no-deal’ territory with WTO tariffs and all the guff about lorry queues, food and medicine shortages again. So welcome to 2020, a year of Brexit, missed deadlines, extensions, and cliff-edge no-deals. Everything changes but everything stays the same, can’t wait!
…and whisper this as well
Had enough of elections, political mud-slinging and opinion polls? Me too, so what a shame we’ll have to go through the same again, only stateside. It’s the US Presidential election in November, preceded by the primaries. Assuming he’s not in jail, Trump will be the Republican candidate so the interest is on the Democrat side. Joe Biden is the establishment choice but (sorry for being ageist) doesn’t look full of vigour and youthful promise and nor does moneybags Michael Bloomberg whilst Bernie Sanders, standard-bearer for the socialist left, but has a touch of the Jeremy Corbyn about him. This leaves us with the most interesting candidate Elizabeth Warren, the leader of the parties liberal wing and fiercely anti-Wall Street and big business with a break-up of the tech behemoths and a ban on oil fracking high on her agenda. She does not support public ownership but is a strong proponent of wide and strict regulation to keep the full forces of capitalism in check to protect the poor and exploited. If Warren were to make it to the White House she would find her wings clipped by the courts, the States and possibly also the Senate. Nevertheless, chill winds would blow along Wall Street and investors who rail against Trump might want to be careful of what they wish for.
The M&G Property Portfolio Fund
It is important to provide you with more detail regarding the temporary suspension of dealing in the M&G Property Portfolio fund. Specifically, I’d like to discuss two issues:
- What is the outlook for the fund regarding the length of the suspension and the risk of loss of capital?
- Why were we still holding the fund on some client portfolios when it was suspended?
Outlook for the Fund
I understand investor concerns about the suspension in dealing, not least because it comes hard on the heels of the suspension of the Woodford Equity Income Fund, whose investors are facing a long suspension in dealing and the likelihood of a considerable loss of capital. This suspension is very different, the Woodford fund comprised illiquid shares in small companies for which there will likely be few, if any, buyers. The M&G fund is invested in real, physical assets such as office buildings and shopping centres, which are held for the long term and take time to buy and sell. Hence, following a sustained period of redemptions the fund has suspended dealing in order for the fund managers to restore cash levels by selling assets in an orderly manner to best preserve value for investors rather than in a panic fire-sale. Thus far the fund has raised £137m in asset sales, to give some context they would need to raise £500m to give a cash buffer of 20% as the current fund size is £2.5bn.
There is a precedent. Following the Brexit Referendum in June 2016, M&G, along with other daily dealt ‘bricks and mortar’ commercial property funds, suspended dealing in July, following a high level of redemption requests. The price of the fund was initially marked down, the fund was re-opened for dealing in November 2016, following a closure of four months and by the middle of 2017, the unit price was back above that at the time of gating. There are currently no indications as to how long the suspension will be this time, though I would anticipate it to be at least until the middle of this year.
Why were we still holding the Fund?
We were aware of the deteriorating outlook for UK commercial property and had been actively reducing our exposure to the sector throughout 2019, by selling the Aberdeen UK Property fund and in some instances, reducing M&G. Long term though, we continue to believe commercial property plays an important part in diversified client portfolios, having a low correlation with the equity market and producing a high level of income for distribution to investors. Technically, unlike equity and bond funds which trade with a minimal if any bid/offer spread, property funds have a spread which can be as large as 6%, thus selling and then re-purchasing can be punitive and something we have always looked to avoid.
An alternative would be to use REITs (real estate investment trusts) as the vehicle to invest in property. We do this for very high risk/reward clients only as REITs are in themselves equities, which have a much closer correlation to the equity market and so can be very volatile, particularly in a period of heavy investor selling which can drive the price down significantly.
We do of course apologise for the inconvenience and worry this suspension is causing you and will keep you fully updated any time we receive more information from M&G.
Scores on the Doors
Bumper, bonanza, boisterous, bounteous returns from equity markets last year after the traumas of 2018. The dispersion in developed market returns narrowed in the last quarter as that notorious laggard, the UK equity market, pulled up its skirts and sprinted down the finish straight in the ‘Boris bounce’. This was accompanied by a rise in the pound, which reduced returns from overseas markets when translated back into sterling. Bond markets have been perky all year with prices rising /yields falling following the Fed volte-face and a slowing global economy but have marked time in the last few months. The ‘risk-on’ mood of the last quarter led to a tightening in credit spreads such that corporate bonds outperformed government bonds. In equity markets, growth sectors, notably technology, continue to outperform the value sectors like energy and materials, though there was a sense that this decade long trend may be running out of steam. Financials continue to struggle in the super-low interest rate environment, though all sectors racked up solid gains in such strong markets.
The oil price was stable in the last quarter. Modest demand and plentiful supply imply little upside, though geopolitics and Middle East conflict may tear up this script. Gold also marked time having raced to its highest level since 2011 earlier in the year, finally breaching the USD1500/oz level. Absolute Return funds continue to disappoint, and we have reduced our exposure significantly over the last two years.
Conclusion….The Whimpering Twenties
As an exercise in masochism, I looked back with some trepidation at what I had written in the Q1 2010 newsletter as my forecast for the next (i.e. last) ten years. Gulp, well actually not too bad, as I wrote ‘longer term we are optimistic that the tens decade will prove to be more rewarding for investors than the noughties’. What was not so smart was that I was bullish on Emerging Markets and liked those oh so clever Absolute Return funds. So will the next decade be the ‘Roaring 20s’? Probably not, because valuations for both equities and bonds are already at stretched levels and we are in very extended economic and stock market cycles. One year is a long time to forecast market returns with any sense of certainty, let alone ten, and we certainly don’t have 20/20 vision (see what I did there). We do though expect positive returns on an annualised basis for the ‘20s, though of a magnitude less than historic norms. What we also expect is a change in the ‘shape’ of the market with last decade’s winners and losers changing places at some point. I discuss this in detail in the end piece (shameless plug to keep reading). Something else I wrote in the newsletter of a decade ago was ‘two things tend to arrive unannounced in life, opportunity and trouble’, this was true then and will remain so for the next ten years. As for this year, our hope (as it is every year) is for positive returns with little market volatility but this is a New Year’s resolution seldom kept.
The ending of a decade is an appropriate opportunity for James and I to thank you for allowing us to manage your investment portfolios. This is a responsibility we take very seriously and whilst we try and follow the adage ‘do not let success go to your head or failure to your heart’ we wear our mistakes heavily and our sincere apologies when this has been the case. Along with Becky and Kim on our Operations side, the investment team wishes you a very happy, healthy and prosperous 2020.