More pain to come for investors?

This week, FundCalibre held its annual investment dinner for financial journalists. Speaking at the event were three Elite Rated fund managers.

They gave their views on world economies and the changing environment for investors. The conversation was lively, views conflicting at times, but all very interesting.

The outlook for 2023? Not great. But there are always opportunities to be found.

Here’s a round-up of what they had to say.

Bruce Stout, manager of Murray International Trust

Bruce believes we’re in a very different environment today to the one we’ve been in for the last 15 years. And it’s not going to be easy.

“The R word we should all be worrying about is not recession,” he said. “Recessions come and go with regular frequency. It’s financial repression that is the problem. It’s the legacy of 15 years of bond price manipulation that allowed politicians to get away with murder.”

Bruce says that inflation has been in the market ever since the global financial crisis, when central banks started manipulating markets and governments took on huge amounts of debt to bail out economies.

“We’ve been inflating government balance sheets. We’ve been inflating property prices, inflating multiples in equity markets, inflating expectations. And people thought this was the norm,” he said. “The inflation today is not a covid phenomenon, it is a monetary one.”

“Governments have allowed the wealthy to get very rich and allowed the middle classes to muddle through by taking on more leverage. That was sustainable in a 2% world – a world where inflation was 2%, bond yields were 2% and wage growth was 2%. But it isn’t sustainable in a 5% world. And a 5% world used to be the norm.”

Bruce points out that the last time inflation was 12%, interest rates were 15%. “The banking system would go bust today if that happen though, and we’d experience the deepest depression ever,” he said.

He points to problems with wage inflation due to aging demographics and the potential for more structural inflation as geopolitical tensions and supply chain issues result in companies ‘onshoring’.

“In the UK, we had mobility of labour for 30 years, so real wages fell. Today that has stopped. It’s been made worse due to Brexit – we cannot get labour – and we have an aging demographic,” he said.

“Supply chains pre-covid were about ‘where is it cheapest’. But with geopolitical tensions, onshoring of companies will make things more expensive – creating more structural inflation.

“So, optionality is very limited for the developed world and when it comes to
investments, you need to find businesses with a tail wind. Businesses that are not affected by inflation, rising interest rates or supply chains, etc.”

Mike Riddell, manager of Allianz Strategic Bond

Mike agrees that there has been an ineffective use of capital in recent years.

“When you look at bonds, financial repression has meant negative real interest rates,” he said.

“Interest rates were too low for too long. Central banks are making up ground this year but have gone too far the other way. The market is currently saying that inflation will fall next year but interest rates will stay above the inflation level.”

Mike says that interest rates take about 12 months to have an effect on an economy, so we have only just started to feel the pain. “Most of it will come in the first half of 2023,” he said. “That means we are barely half-way through the process.”

He says house prices are the most sensitive to the economy and that “We’re at the start of a massive house price correction.”

“But I think the main reason inflation is high, is not because of quantitative easing (QE) – I disagree with Bruce there because I don’t think it would have a 12-year lag,” he said. “I think it’s due to a series of supply chain shocks. It IS a covid phenomenon. We would have seen inflation in 2015 if it was due to QE.”

“Supply bottlenecks are almost entirely gone now,” he continued. “Supplier delivery times are back to pre-covid levels. Freight costs too. The reason inflation is still high today is because of the commodity price surges.

“In six months’ time, the oil price will be negative year on year, so deflationary. It will come out of the numbers. So, I think inflation will fall from about the second quarter next year. Economic growth, however, will be horrific.”

So where does this leave bonds?

“I’m the most bullish on government bonds I have been in my career,” Mike said. “The fund is also the longest duration [sensitivity to interest rates] it has ever been. If I’m right, bonds are phenomenally cheap. If there are fewer interest rates hikes than are priced in, that would be enough to start a rally in bonds.

“I don’t believe inflation will be at 5% forever,” he concluded. “If you look at Japan, inflation didn’t go up and that has had aging demographics and demand shocks too.”

Alexandra Jackson, manager of Rathbone UK Opportunities

Alexandra also agrees that we have barely started to see recession or the impact of rising interest rates. “This year, the stock market has fared badly,” she said. “Next year it will be the economy weakening. But recession does not equal lights out for companies – you just have to avoid the ones with large debt.

She says that while the FTSE 100 and oil and gas companies in particular have
been in positive territory, it has been due to supply constraints not heavy demand.

And other areas of the market have not held up so well.

“UK mid-caps have borne the brunt of the sell-off and are down some 22% year to date,” she said. “And that’s not surprising because mid-caps usually suffer at times of macroeconomic stress. They do still outperform their larger peers over the long term, however.”

Alexandra pointed out that the day US consumer price inflation came in 0.2% lower than expected, UK mid-caps “ripped higher”. “The sell-off in the dollar came on the same day that the UK installed a technocratic government, and it all helped to stabilise the pound,” she said.

“The UK is now cheaper vs the rest of the world than it has been since the 1990s,” she continued. “And the potential reversing of the trends that have weighed on mid-caps in particular – sterling weakness, rate hikes and politics – could mean they start to do a lot better.

“And I’m not alone thinking UK mid-caps could be the place to be next year – David Coombs head of multi-asset investing, and manager of the Rathbone Strategic Growth Portfolio has told me he’s getting excited about UK equities now too.”

“After every crisis, investors gain a new battle scar,” Alexandra concluded. “We become more sensitive, and any resurgence has an impact on us in the future. Now, if we hear the word ‘stimulus,’ we’ll get nervous about inflation.”


Photo by Aarón Blanco Tejedor on Unsplash

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