William Bourne attends the 15th Annual Local Government Pension Investment Forum

On 11th October 2017, William Bourne attended the 15th Annual Local Government Pension Investment Forum in London. 

William Bourne attends Invesco investment discussion dinner

On 4th October 2017 William Bourne attended the Invesco investment discussion dinner in London.

Upcoming events

Please find below a selection of upcoming events William will be attending:  13th October 2017 - Fidelity UK institutional conference, London 23rd November 2017 - SPS Spotlight Series - LGPS in Flux - Investment Issues and Solutions, London       

William Bourne attends Lazard Briefing Series

On 29th September 2017, William Bourne attended the Lazard Briefing Series - 'Can emerging markets continue their blistering run?' - in London.

William Bourne attends Jupiter institutional investor lunch

​On 28th September 2017, William Bourne attended the Jupiter institutional investor lunch in London.

Japan - coming off the fence on the side of the bulls

I wrote an update a few weeks ago on Japan (‘Japan - Glass Half Full? Or Empty?') arguing that the market is being pulled between positive and negative factors.  At that time, I sat on the fence which way it would fall but things have, as is their wont, moved on. Most obviously, Prime Minister Abe now looks likely to call an election this autumn on the back of a disorganised opposition and North Korea’s provocation.  He may still look at the spectre of Theresa May and draw back, but it is probable that he will win a mandate out to 2021.  This would give him another four years to wear down the bureaucrats, particularly in the Ministry of Finance, who form the stoutest opposition to Abenomics. It is also becoming clearer that the Chinese economy has weathered the travails of 2015 and is on its way back up.  The evidence is in the capital flowing back into China, as much as the headline data. This is important to Japan, which since the war has developed from being an outsourced manufacturing offshoot of the US economy (I exaggerate, of course) to a producer of high-end goods for the world.  They now find themselves primarily as an intermediate goods producing satellite of greater China’s: for example, consumer goods imports from China are very roughly equivalent to exports of intermediate goods back there, in considerable contrast to Japan’s trade surplus with the US.  At a simplistic level, a stronger Chinese economy can only be good for Japan. There is also the suggestion from our friends at CrossBorder ('Japanese Monetary Policy in a Chinese-Dominated World') that that as their economy has become more linked to China’s, Japanese monetary policy has shifted too.  Historically their focus has been on preventing extreme yen strength against the US dollar but it looks as if it is turning to a more pro-cyclical one of aiming for currency stability against a basket of Asian currencies.  It may be a symptom of this change that, whereas historically a strong yen/dollar exchange rate has tended to mean a weak Japanese equity market, over the past couple of years we have seen periods of market strength at the same time as the yen has strengthened.  What does this mean for the Japanese equity market?  I will come off the fence and suggest it is probably positive overall, mainly because a renewed Abe term reduces uncertainty and it appears that Japan has found an economic model to replace the post-war one based on the US.  But I’m not as bullish as some: the scope for policy error remains, foreign investors are no longer underweight and Japanese corporate cashflow remains subdued, albeit slowly improving.​

THE REVERSE YIELD GAP RE-EMERGES

Clearing out some archives the other day, I came across a research paper written in 1978 on the subject of the relationship between equities and bonds.  The Yield Gap (ie. the spread between the equity and bond yield) was of course a staple relative valuation measure until it became the Reverse Yield Gap in 1958.  In recent years, as bond yields plunged, it again became, at least until very recently, the Yield Gap but it seems that investors do not pay it the same attention. I do not know the author of the paper, except that his (I assume his) initials were ebd and that it was written on behalf of the Common Stock Research Committee, by which I imagine he was American.  I reproduce below the historic path of the Yield Gap until 1978 but perhaps what is interesting is the conclusions he drew. The first is that bond and stock yields usually move in the same direction, at least in the long term.  The author acknowledges that in the short term that may not be the case; in contrast I can remember as a graduate trainee a senior bond manager describing an afternoon when both equity and bond yields fell in unison following an interest rate cut as being ‘unusual’. He thought that the reverse spread was a reaction to increased fears of inflation following the 1957 recession, which unusually did not create deflation.  He suggested its persistence was due to higher return on equity and he quotes 13.8% for the period 1973-1978.  Today both inflation and returns on equity have fallen, so he would correctly have predicted the 2008 re-emergence of the Yield Gap in place of the Reverse Yield Gap.  My old professor at the London Business School, Paul Marsh, theorised that the Yield Gap should be the expected risk premium on equities minus the growth in dividends.  But, as he pointed out, we can only observe the equity risk premium in retrospect. Ebd did not believe that inflation was a significant factor in equity markets, citing that two major bull markets had been in deflationary conditions and one during inflationary times.  We can broadly add further bull markets in deflationary times in the 1990s and since 2009, so might choose to disagree with him on this point. Perhaps most interestingly, writing at a time when the biggest bull market in history was about to begin and the Reverse Yield Gap was extreme at 384bps, he didn’t believe that stock prices were either ‘grossly underpriced or overpriced’. Today we again find ourselves with a Reverse Yield Gap, albeit small at 20bps (US 10 yr bond yield at 2.1%, S&P 500 1.9%), ie. just outside the long term range showed in the chart below.  Does that make equities ‘neither grossly underpriced nor overpriced’?  It is worth noting that if bond yields were to go to the upper end of the historic Yield Gap range they would have to rise by about 200bps compared to equity yields.  Or are we too at a turning point and unable to see a major inflationary sea-change approaching, much as in 1958? 

​THE US DOLLAR WILL BE WEAK, BUT NOT BECAUSE OF TRUMP

At Linchpin, on the back of the work at our colleagues from CrossBorder Capital, we have been gently but consistently bearish on the US$ for a number of months now.  We have been eyeing the deterioration in the quality of US capital flows, both domestic and overseas, in particular because  this is always a harbinger of a weaker currency eventually, regardless of interest rate differentials and The Federal Reserve’s policy statements.We see two major trends leading to a weaker dollar.  The first is the cash piles held by US corporates outside the US.  US banks have since 2012 increasingly re- lent these back into the US and borrowed Eurodollars against them.  The effect has been to boost US cashflow, effectively hiding the deterioration in cash generation from operations,  and to leverage the US corporate sector.  Today, these flows are drying up and we believe the effect will be to expose the shortage of operational cashflow from the corporate sector.  The effect on US eps growth can be hidden for a while but not for ever. The second major element is the flood of ‘safe haven’ money flowing out of US Treasuries, in particular into China, Europe and Japan as their economies recover.  Our friends at CrossBorder Capital calculate around US$3 trillion, or 5% of total US liquidity creation in this period, went in the direction of the US in 2014 and 2015, but since early 2016 the tide has been setting in the other direction. So we would argue that the US$ has in recent years been the beneficiary of two temporary flows of capital, both of which are slowing and reversing.  Against this is the Federal Reserve’s gradual tightening of monetary policy over the past two years, which economics 1.01 tells us should act as lower US$ supply and therefore a higher 'price'.  We would expect the US$ to be significantly weaker over the next 12 months.  Note we haven’t even mentioned the vagaries of Trump politics! A weaker US$ is both good and bad for investors.  It will act as a further boost for Emerging Markets, a Linchpin theme for some time.  However investors who use global equity managers or index funds will have over 50%, perhaps even 60%, of their assets held in US$.  If we are right, that is a major risk to performance.

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