Watch out for the rise!

Sorry if you thought we mean stockmarkets rising.  We don’t.  We mean liquidity.  Here end-June data from our friends at CrossBorder Capital is showing a significant jump, much in line with our predictions over the last few months.  It’s happening where investors aren’t looking – in Asia and the private sector.  In Asia, the PBoC has clearly taken its feet off the brakes again, perhaps in consequence of the slowing economy as per yesterday's headline.  There’s a sub-theme we’ve mentioned before here too – the Bank of Japan seems to be easing in line with China, bearing out our view that Japan has for several years now targeted currency stability first and foremost rather than foreign currency. The real theme of the latest data is the surge in private sector liquidity around the world but particularly the US.  This is not all good news, as it may be corporates building up cash before an economic downturn.  But it does increase the likelihood of steeper yield curves.  In theory that fits neatly with our general view predicting a bullish steepening with short term yields falling alongside US rate cuts.  However, the facts don’t all fit.  Historically, this late-cycle environment is associated with rising term premia, suggesting that longer term bond yields may in fact rise, and a bearish steepening.  At the same time, one of the worries we have had over the past few months, the fragility of corporate bond markets, seems to have eased off a bit, so the bulls expecting the US to cut rates may be premature.  So, while we expect the curve to steepen as liquidity supply increases, we are less confident which end of the curve will move. QE4 is starting but it seems that the US Fed may be the laggard rather than the leader this time round.  It suggests that Emerging Markets will, at some point quite soon, have a run of some sort but once again not all the facts fit.  CrossBorder flows of capital are running clearly away from emerging markets, and particularly the larger ones such as China, into safer havens mainly in Developed Markets.  Liquidity may well be on the rise, and highly valued US equities may be underpinned by that, but we’re not sure that adds up necessarily to further gains in global indices. If you’d like to see the underlying data, please contact the team.​

Upcoming events

Please find below a list of events that William and Mukesh are attending or speaking at: 10 October 2019 - Investing with Impact Summit - London - William will be attending this summit organised by DG Publishing in conjunction with Pensions for Purpose.  7 November 2019 - LGPS Asset Allocation Forum - London - William will be a panellist on the topic of using consultants in a pooled environment.   

William looks at the prospects for 'value' if there is more qe

Regular followers of our blog will be aware that we think the Federal Reserve has given up on interest rate normalisation, and will meet any serious threat to either the economy or the financial system with rate cuts.  It’s noteworthy that US 10-year yields have fallen from 2.7% to just above 2.0% in the past three months and we expect them to go lower. What does that mean for equity investors and value investors in particular?  They have suffered from QE, as lower discount rates have pushed up the valuation of longer duration assets such as growth stocks, and also from investors’ desperate search for income in an ultra-low bond yield world.  In May 2019, some 11% of global stocks traded at more than 30x and a further 12% at below 10x.  In Japan, the numbers were 16% and 22% respectively. That tells a story of investors buying quality and growth and shunning value.  Will it continue if we do indeed find ourselves staring down the barrel of QE 5, 6 and 7?  At the moment, we don’t see much to stop the trend continuing.  The shortage of safe assets is pushing bond yields down and we suspect that genuine ‘quality’ equities, i.e. those which can credibly promise steady income growth over the long term, will benefit in turn. However, no trend lasts for ever and there are things in the offing which will ultimately lead to change.  The first is that, almost universally, the highly rated companies are large global entities in sectors such as consumer goods, pharma and increasingly technological.  The threats will come from increasing friction in global trading, and determination by governments to clip their wings and stop them becoming too powerful.  Who remembers the currency controls in place in the UK until 1979? The second, at the other end of the spectrum, is the growth of private equity.  The FT reported this week that there is US$3.5 trillion of ‘dry powder’ waiting to be invested.  Some of that will be aimed at the unloved and lowly valued tail of listed companies, which should in time give valuations a fillip. In conclusion, another phase of loose monetary policy may look like the 2009-2017 period to start off with and indices may well carry on rising.  But we believe it will be just a little more friendly to the value end of the spectrum too.

william participates in asset allocation panel at lapf strategic investment forum

On 3 July 2019 William participated in a panel on asset allocation at the LAPF Strategic Investment Forum in Hertfordshire.​

Mukesh Malhotra attends MJ Hudson Allenbridge and M&G Investments DB dinner

On 26 June 2019 Mukesh attended this reception and dinner on DB pension schemes and end game planning in London.

Recession or no recession?

Talk of a recession in the US is again in the air.  Last autumn, when the Federal Reserve was on its path of ‘normalisation’ by increasing interest rates, we thought a recession close to inevitable.  The authorities have changed tack abruptly, and we commented in January that it might or might not be too late to prevent a US downturn. More recently we have had that classic sign of recession, an inverted yield curve, as US longer bond yields have fallen beneath short rates.  As a result, recession talk has risen.  We have two reasons for believing that, while it is certainly a possible outcome, it is not yet baked in.  We have written before why there are technical reasons for the sharp fall in longer term US bond yields, which are more to do with the financial system’s demand for ‘safe assets’ and less to do with risk appetite.  We also note that our friends at CrossBorder’s major liquidity index at the end of May was still just above recession level, and policy stance at both the Fed and PBoC in particular are close to neutral.    That said, what we have noticed is a sharp fall in investors’ risk appetite as measured by cross-border flows and investor sentiment.  It looks as if more investors have already positioned themselves for an economic downturn, which suggests the market impact of one may be less dramatic than expected.  We also believe, as we have commented before, that the Fed would react with a new QE programme.  This would aim to limit the extent and impact, much as in 2008/9. So, recession or no recession?  We don’t know the answer and we don’t wish to sound overly complacent.  However, we are not yet convinced that a recession in the US is certain and we do believe that, if there is one, the impact on markets will be short-term rather than extended.​

Whither markets? Are we looking at QE 5, 6, 7, 8...?

We pondered the different messages coming from equities (generally rising) and bond yields (falling) three months ago, and concluded that bonds were more likely to be right in predicting a downturn.   We have consciously shifted our ground since then - we make no apologies for doing that.  For us the importance lies not so much in the Fed’s short-term shift to a neutral position, which makes a benign outcome more likely.  Instead we are more focused on the longer-term message the Fed is giving: that normalisation of interest rates is going to take a great deal longer than you first thought. In our view the key implication is that the Fed is less concerned about inflation, and more so about risks to the financial system, in particular the lack of ‘safe’ assets such as T-bills which are used as collateral across a range of wholesale transactions.   If that is the case, whither markets?  We suggested a month ago that US bond yields would fall further, perhaps dramatically so, and the 10 year yield has responded by dropping 40bps in four weeks.  It is still well above the 1.5% yield reached in 2016 but looks headed that way.  We’d like to think that the shortage of ‘safe’ assets is behind this buying and that it is not a precursor to an economic downturn.  But bonds have a strong record of predicting recessions and the yield curve is not far off flat at the time of writing.  So we are wary of positing that this time it is different.   If there is a significant downturn, it seems to us almost inevitable that the Fed will turn on the printing taps again with QE4, 5, 6 or whatever it takes.  That makes us more confident that 10 year US bond yields will, at least initially, carry on falling, quite possibly to new lows. And equities?  On the one hand lower or negative economic growth should depress stocks, especially as valuations are (sky) high.  On the other hand, lower bond yields may force income-seeking investors to purchase blue-chip equities as they did in 2015 through 2017.  Our best guess is that, in the absence of geo-political convulsions (trade wars etc), they broadly trade sideways.  Any dip would be fairly quickly covered by buying but the upside is limited by low dividend growth and valuations. Perhaps the most troubling aspect of not normalising is the distortions that cheap money brings to markets.  Asset prices such as housing remain excessive, zombie companies are not put out of their misery, while the incentive for profitable companies to invest in new capital reduces because returns are competed away.  The new normal may seem more comfortable than an old-fashioned recession but it is certainly not nirvana.​

Is governance in the LGPS fully aligned with TPR’s viewpoint?

​Earlier this year Hymans Robertson was appointed by the Scheme Advisory Board (SAB) to facilitate a review of governance structures for the LGPS.  The major issues have been conflicts arising between the administering authority and the pension fund, often centred round the role of the 151 Officer legally responsible, and lack of clarity and accountability between different roles and stakeholders. It is quite clear from The Pension Regulator’s presentation at the PLSA conference last week that their understanding of accountability is different from the LGPS community.  TPR’s focus is on local pension boards (LPBs) – witness the fact that TKU requirements in the public sector code of practice (COP14) apply to board members but not the pension committee members who actually take decisions.  Given that LPBs have no executive powers and very limited sanctions, this cannot be right.  Either TPR in concentrating on LPBs has misunderstood how the LGPS works, or their focus is deliberate but misplaced.  Either way, it leads to two glaring loopholes in governance: LPB members are accountable for non-compliance despite having no powers and there are no training requirements for those committee members who do have the (delegated) powers. We welcome the Hymans’ Good Governance project.   In our view a good outcome will be to clarify the relationships between the various stakeholders managing the fund.  These are primarily the administering authorities, the 101 committees with delegated powers and pension boards whose role is to ‘assist’ the administering authorities.  However, equally important are the other stakeholders, the members whose pension money it is and the employers who bear the brunt of contribution changes. Hymans are looking at four models, of which we think three would be feasible.  We would like to see clarity of responsibilities and duties (and TPR’s COP14 fully aligned with whatever is ultimately decided) and processes for dealing with conflicts of interest.  Above all we would like to see effective remedies for poor performance, particularly as pooling and shared services are an increasingly common model.  In the private sector, one can always terminate contracts but that isn’t the case here.   Read more about Linchpin’s approach to advising on governance here.