Fully invested bears
In the last couple of weeks, I have sat through several presentations by large city fund managers reviewing the performance and outlook for multi-asset, global portfolios that they manage for institutions that I consult to.
There is an interesting unanimity of opinion that the correction in equity markets in October was just that, and it will not turn into a prolonged bear market whilst Europe and Japan continue with QE and the Fed only raises rates gradually.
It will not turn into a prolonged bear market whilst Europe and Japan continue with QE and the Fed only raises rates gradually
Slowing global growth is considered temporary, the Chinese slowdown in particular will be well managed by their authorities and lower oil prices offer a positive stimulus to consumers which will outweigh the producers’ pain. Whilst acknowledging government bonds and the US equity market are expensive, their favoured QE driven equity markets in Europe and Japan are thought to offer scope for further substantial gains.
My regular readers will know I am less optimistic that the transition from ultra-low interest rates, particularly in the US, will run this smoothly, for the simple reason that I think cheap debt has been the main driver of the equity and bond bull market since 2009, creating a virtuous cycle that provided excess liquidity and driven corporate profit growth through debt leveraged buy backs.
Already in the UK several big food retailers, banks and miners have cut their dividends.
This has left equity valuations elevated whilst earnings growth is slowing. The comfortable cushion of much higher equity yields compared to government bond yields is likely to be squeezed in two ways. Equity dividend pay-outs have been generous, which has left pay-out ratios looking vulnerable. Already in the UK several big food retailers, banks and miners have cut their dividends. Bond yields have been driven lower by QE and sovereign wealth fund purchases, both now under pressure in some markets as lower oil prices have slashed the cash flow of many oil producing countries.
Corporate bond spreads have been rising. According to Bloomberg, US 10 year spreads are up from 220 basis points in mid-2014 to closer to 350 basis points now. M&A is now back to levels seen at the peaks in 2000 and 2007 and should be seen as a contrary indicator.
Time will tell whether slowing global growth at a time of bond market weakness will be sufficient to turn the virtuous cycle into a more vicious one.
But should it happen it will be interesting to see the reaction of governments and central bankers around the world, who look to be unusually short of policy options for this stage of the cycle.
When challenged on their bullish views the typical response of the fund managers was agreement to the deteriorating state of the fundamentals, but a seeming inability to change conclusion because of the lack of acceptable alternatives — leaving me to conclude many are fully invested bears.
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Gregor Logan is an independent investment management specialist with more than three decades of senior-level experience in all asset classes including equities, bonds, property, private equity, alternative assets and hedge funds. He previously held leadership roles at Fidelity Investments, Pavilion Asset Management, and New Star Asset Management.