Please find below the notes from GAM Investments’ Weekly Investment Meeting held on 12 September 2018 – this week’s speakers were Larry Hatheway, who discussed global growth and the twin risks to the current benign backdrop, and Adrian Owens, who talked about the opportunities in rates and currencies
14 September 2018
Global growth remains intact. While US growth likely peaked at around 4% on an annualised basis mid-year, the combination of still supportive fiscal policy and rising household income – courtesy of both job and wage gains – rising capital expenditures and still accommodative financial conditions suggests little risk of a sharp slowdown ahead. Growth also appears to be picking up in Japan, led by capital expenditures. China is gradually relaxing its credit policy to offset a potential trade-related slowdown, while services and consumption continue to support the Chinese growth story. European growth lags, but the combination of full employment and still accommodative financial conditions limits downside risk. Emerging markets are the chief area of concern, given rising risk premiums and the cost of capital, but apart from recessions in South Africa and Argentina the adverse spillovers from emerging markets to the rest of the world economy ought to be limited.
The twin risks to this benign backdrop remain an escalation of the trade conflict, which then slows corporate spending, or an unexpected rise in inflation, that prompts concerns of aggressive monetary policy tightening. The first of these risks is difficult to evaluate. It remains hard to envision near-term negotiated outcomes to trade conflict, given the politics involved, but it is also not clear that a sharp escalation of tensions must ensue. Regarding inflation, wages and prices are rising at a faster clip in many advanced economies, but thus far the rate of this acceleration remains modest and non-threatening.
In terms of our asset allocation views, our tactical models suggested a move to ‘risk on’ a few weeks ago and, accordingly, we marginally increased our allocations to global equities. Yet our overall stance remains cautious with a preference for quality, sound business models (eg in information technology) and buyback candidates, accompanied by short duration credit holdings and non-directional strategies.
Interest Rates and Currencies
We believe we are approaching a point where there are some really good opportunities in rates and currencies. A number of our key themes are incredibly stretched, in many cases at 30-year wides relative to history and fundamentals.
On the rates side, UK spreads, relative to markets like Canada, are at 30-year wides. Historically, this sort of differential has not been maintained for long, especially since there is currently higher inflation in the UK combined with less favourable debt dynamics. This scenario is primarily down to Brexit concerns, but we believe there is so much bad news already priced in that it makes no economic sense. Investors in the long end of the UK are guaranteeing, unless inflation collapses, they will be losing money every year for the next 10 years in real terms; therefore there is a good opportunity to go short in our view.
We believe emerging markets local currency is beginning to look more attractive, particularly in the shape of Mexican rates which offer 8.5% returns on 10-year rates. With inflation under control we think the central bank has probably finished its hiking cycle. In South Africa fundamentals are not quite as strong, but with yields at 9.5% on 10-year rates it is also starting to look attractive.
With regards to currency, the Swedish krona looks very interesting. We have argued for some time that the Swedish economy is strong, inflation has moved back up to target and the central bank would likely respond in due course by raising rates. In terms of the economics we have been correct, however where we have been wrong is on the reaction from the central bank. It has sat with QE in play and interest rates at -0.5% and has allowed inflation to move up to 2.25% without any response. Typically central banks tend to be forward looking – we have seen this with the Norwegian central bank – but Sweden, largely because of the mistakes it made in 2010 in our view, has been very reluctant to do anything. It also has half an eye on what the ECB is doing and worries that if it goes too quickly or aggressively ahead of the ECB the currency will strengthen too much. Because of its actions the currency has actually continued to weaken. Given the currency is as cheap as it has been in a long time, many discretionary investors have jumped on this trade only to then become frustrated that it has not worked and have stopped out. Conversely, many systematic funds have maintained their short Swedish krona position. This is not surprising to us as, technically, the market is now in a better position and fundamentally the missing link of higher rates looks like it may be around the corner. At the latest Riksbank meeting it said unless things go horribly wrong it will hike rates in either December or February, so the story looks poised for a turnaround.
Norway is not in a dissimilar position, with the Norwegian krone also weak, oil prices high and the economy doing well. This is another currency which we feel represents some real value. The central bank meets later this month and we expect it to hike rates; in light of some of the recent data coming out of the country it is likely to be a hawkish hike. Headline inflation stands at 3.4% and underlying inflation has moved fairly quickly from 1% to 1.9%. So as with Sweden, everything looks to be in place. If we are right, over the next six to eight months returns from both areas could be encouraging.
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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.