Pencil in 2019 for the next economic downturn

Our friends at CrossBorder Capital have released end June liquidity data and it shows the same very tight conditions as we have highlighted for three months.  They normally - I hesitate to say always - presage a significant downturn in risk appetite and markets, and then economies.  The overall liquidity index is 17.3 (range 0-100) but that hides a more positive picture for Emerging Markets (58.3) than Developed ones (12.7).  The former appear to be letting their currencies weaken rather than tightening monetary policy in line with the US Federal Reserve. Investors’ appetite for risk also appears to have declined, albeit the confidence collapse is largely within Emerging Markets and specifically China.  This tallies with our anecdotal evidence, where many western investors we speak to remain invested in largely DM risk assets in the short term, despite their worries about the longer term.  Our own view is that there is a lot of complacency around after nearly ten years of rising markets, and we are firmly in the ‘Risk Off’ camp right now across the board. With the liquidity cycle clearly in a downward trend and the risk cycle looking like it has peaked, we would expect the economic cycle to follow and peak quite soon.  We are therefore somewhat sceptical that the train of rate increases envisaged by the US Federal Reserve will all happen.  If they do, we suspect they will prove the exogenous shock needed to precipitate a change in market direction and economies will slow sooner rather than later.  Either way, we now have visibility of how the next economic downturn happens and, increasingly, when.  Pencil in 2019. To purchase the full CrossBorder Capital report with the end June liquidity highlights, please click here.​

William bourne attends lapf strategic investment forum

On 16th-18th July 2018, William attended the LAPF Strategic Investment Forum in Hertfordshire.

Upcoming events

Please find below a selection of upcoming events our team members will be attending:  13th September 2018 - The Great Unknown - the future of UK Pensions (hosted by Pinebridge Investments) - London - Mukesh attending 20th September 2018 - LAPF awards dinner, London - William attending          

Review of CIPFA guidance on Local Pension Boards

CIPFA has recently published their Guidance for public sector pension fund Local Pension Boards.  It reads more like an essay rather than traditional guidance, but there are plenty of ideas and examples to provoke thought.In particular, we agree with the suggestions that boards should: Meet before rather than after the main Committee (or equivalent) meeting.Have access to the exempt papers on a timely basis, which is not the case for every Board.Review items such as the risk register and COP14 compliance on a rolling basis.Focus on where functions are outsourced – we would add that this includes pools.Collaborate when reviewing the activities of pools. We particularly like the reminder that Boards “shall have the power to do anything which is calculated to facilitate, or is conducive or incidental to, the discharge of any of its functions” under 106(8) of the 2013 LGPS Regulations.  It is a reminder that it is not the case that Boards, like Beatrix Potter's Mr Jackson, ‘have no teeth, no teeth, Mrs Tittlemouse’. We would argue that more could and should have been made of how Boards add value.  This is primarily in their role representing employers and members, but also where, as in many cases, they can bring specific expertise to bear. The Guidance notes that the Scheme Advisory Board’s Guidance to the effect that Boards’ role may include “assisting with the assurance of transparent reporting from pools and ensuring the effective implementation of strategies by pools. Such involvement should include the consideration of provision of direct representation on oversight structures”.     It is the last sentence that causes us concern.  It seems to us that Boards should focus on assisting their Scheme Manager on the governance structures around pools and not get involved in direct oversight of the pools.  We note that the CIPFA Guidance’s governance diagram does not include any line between the Local Pension Boards and the pools, and in our view that is how it should be.  We do not see how direct representation will help and we believe it will lead to reduced governance clarity. To learn more about how we can help with governance matters please click here.​

Are LGPS funds missing an ESG investment trick? - LGC, July 2018

 The application of ESG risk analysis within fixed income credit was discussed at an LGC roundtable event sponsored by Insight Investment. William was one of the participants.  To read more please visit LGCplus.com.  

Value investing in Japan will have its day in the sun again

A Nomura report claimed a couple of years ago that ‘Japanese value investors are extinct.’  That is not quite true but, since the Global Financial Crisis, only the most determined investors have kept going.  Relative returns from value stocks actually bottomed out in 2016 but there is little sign of any escape from the value trap which scornful commentators like to refer to.   The cause is not hard to seek: Japan has endured ultra-low interest rates for nearly 30 years and negative nominal economic growth for the first 20 of them.  Investors have responded by putting a huge premium on those stocks who have been able to demonstrate growth and/or a sustainable yield.  The dispersion between growth and value has therefore risen to extreme levels. And yet, and yet… since 2001 Japan Inc. in aggregate has consistently generated positive free cash flow, the economy has generated positive real growth over the past three years and where else in the world can you find thousands of companies on a Price to Book of less than 1.0? One clear message from history is that when relative valuation measures become stretched (for example 2001 and 2008) there are excellent returns for value investors who are prepared to stick to their last.  We believe that will happen again but, as ever, patience will be required to benefit. Our friends at Arcus Invest, one of the Japanese value survivors, have written a further instalment of their regular white papers - Fortune Rota Volvitur (loosely translated as ‘value investing will have its day in the sun again’) - on this subject with much more detail.  Please let us know if you would like to see a copy.​

Hold on to your hats!

We make no apologies for returning to the same theme as two weeks ago, when we commented that the global tide of liquidity was rapidly retreating.  The US 10 year Treasury yield has fallen from above 3% to 2.87%, which in our view is further corroboration that investors are moving back to safe havens.  It is all the more interesting that this is happening while Japan and China have stopped investing in US Treasuries.  The two countries’ combined holding is just under 36%, compared to 40% three years ago and 46% seven years ago.  China is recycling excess cash into its Belt and Road policy, while the driver in Japan is a recognition that China is now its most important trading partner.  The more rapid escalation of trade sanctions driven by Trump is further exacerbation. China’s action over the weekend to cut bank reserve requirement ratios by 0.5% is further evidence of the stresses which are building up.  The PBOC is attempting to deleverage over-exposed parts of its domestic economy, while avoiding too much of an economic slow-down, much as it did in 2016. The signal from global liquidity levels is unambiguously negative, as we commented in our last blog.  We said then that what happens in China would probably determine how quickly the next major economic downturn would hit the world.  The latest action can be seen as a positive in that it is effectively monetary easing, but negative in that it highlights the problems. At Linchpin, against the background of tightening liquidity, we are bracing ourselves for a much more serious market downturn than the one experienced earlier this year, and are firmly Risk Off. Expect US rate rises to be muted, and possibly a bearish inversion of yield curves (ie. where short rates are higher than long term bond yields). Linchpin provides experienced advice from our 35 years of investing including how to invest successfully in market downturns.  Find out more here.

The liquidity tide is going out!​

There is no doubt the liquidity tide is retreating fast.  It has been falling since last August and the series monitored by our friends at CrossBorder Capital shows that the global level has only been this low twice in the last 40 years.  Once was ahead of the Savings and Loans crisis in the late 1980s.  The second was in 2007 – I need say no more.  Worse than that, three measures which are the strongest predictors of a bear market are all at extreme levels: investors’ risk appetite is high, central bank liquidity is low and cross-border flows, particularly those out of the US, are weak. That’s not to say it will happen tomorrow.  There are still some positive signs coming out of China in particular, where in a Trumpian world the People’s Bank is rapidly taking over from the Federal Reserve as the global liquidity provider of last resort.  But if they turn the taps off too, it really will be a case of battening down the hatches. When the tide retreats, who will turn out to be swimming commando?   They will almost certainly be found in the Developed Markets and it probably won’t be the banks this time round.  It’s worth noting that markets lead the economy by at least nine months, and it could just be a good old-fashioned recession in 2020 or 2021, with companies which have extended credit to consumers in the forefront.  Think auto and phone service agreements, store cards, travel companies and anybody else who has extended credit unwisely. Find out more about the end May numbers here.      ​  

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