From Macquarie:
We continue to expect return of disruptive volatilities driven by unpredictable public policy cross-currents. As the private sector refuses to multiply money and CBs engage in more extreme and unpredictable policies, the net outcome is likely to be the re-emergence of powerful volatilities; low/declining trading volumes and perpetuation of current low investor conviction levels.
We maintain this largely precludes ‘normalization of monetary policy’. Given current levels of leverage/overcapacity and deep productivity retarding secular shifts, any normalization is socially unacceptable. A far more likely outcome is creeping nationalization of capital markets. As remaining free market signals degrade, the public sector will have little choice but to eventually direct allocation of credit via mix of fiscal & monetary policies, such as consumption supports and public sector sponsored capital formation, with Japan arguably in the vanguard. We maintain that investors, CBs and the public sector will unequivocally cross this Rubicon in the next 12-18mths. The objective will be for public sector to replace non-multiplying private sector and resolve the Mexican stand-off where the public sector feels it is being held hostage by the market.
Meanwhile, low (or negative) rates are likely to keep the global economy in low (stall-speed) equilibrium. While investors are concerned about recession, we maintain the real danger is not recession but rather volatility associated with stall-speeds. Unless public sector strategies are finally able to re-ignite private sector multiplication (thus accelerating real & nominal GDP), the best that can be expected is maintenance of low equilibrium. Unfortunately, in our view, the pervasive impact of secular stagnation largely rules-out private sector escape velocity whilst low cost of capital makes it even less likely that the adjustments required to re-build economies will eventuate.
What does it mean for investment strategies over the next 12 months? We maintain the US$ is the world’s single-most important price, impacting almost all other outcomes as it is the key contributor to market volatilities; ebbs & flows of liquidity and other signals (from PMIs to commodities).
We view Fed’s recent ‘dovish tilt’ as recognition that it is essentially a Global Central Bank and hence it must avoid adding fuel to the fire by minimizing policy divergences. However the Fed faces a ‘Catch 22’. Currency devaluation is the only transmission channel available to Euro and Japan. China and EMs on the other hand, prefer a weaker US$ and stronger ¥ whilst the US economy might be already growing above the trend line. Therefore only QE4 or a much more robust private sector recovery would align Fed with other CBs. Given that we view neither event as likely, we have difficulty seeing ‘Plaza Accord’ currency stability and maintain that a stronger US$ and weaker €, ¥ & Rmb are far more likely.
This macro uncertainty (exemplified by FX) is likely to be compounded by virtually non-existent EPS growth rates across most markets. The protracted stall-speeds are starting to catch up with corporates. Thus, despite recent the ‘trash’ rally, our key investment thesis remains – the non-mean reversionary importance of quality growth, as it is likely to become ever more valuable in the world of no growth. The same applies to our country selections. We value growth & fiscal/monetary flexibility whilst avoiding commodities. This continues to tilt us to India, Phil, China, Korea & Taiwan. Globally, we think Japan is reaching an inflection point and we remain concerned that US equities are vulnerable.
What does it mean for investment strategies?
1. First, we believe that current phase of secular stagnation (characterized by low productivity gains, stagnating real incomes, rising income and wealth inequalities and compressing global demand and trade) cannot be reversed. Indeed current monetary policies by keeping cost of capital low (or negative) are making it worse by precluding market clearance and eroding returns on productive investment.
2. Second, we believe that this implies that until we have more substantive changes in policy settings (either to allow the business cycle to work via market clearance or by embarking on far more aggressive strategies of direct Government control over credit and investment), the high returns (both equities and bond market) that were achieved in the first seven years of QE policies would fade over the next 12-18 months, and investors would be stuck in a purgatory of low or negative real returns (a la 1930s).
3. Third, the change in policy settings towards significantly more proactive public policy in directly driving investment, consumption and credit decisions, would force investors to at least temporarily relocate funds towards reflating economies and sectors that are likely to be direct beneficiaries of Government largesse (such as low cost/end consumption beneficiaries; infrastructure players; quite possibly commodities). In other words, investment style would return to the type of investment that prevailed in China in ‘90s, where the only question was what would the Government do and how investors would benefit from these policies, either indirectly or through various asset injections.
4. Fourth, as we saw in Japan over the last 25 years or in the US in late 1960s-mid 1970s, in the world of no growth and no mean-reversion, ability to grow earnings and returns without excessive reliance on revenue growth or leveraging, is likely to continue to be highly prized. Until there is a significant shift towards what consensus currently assumes to be ‘fringe-socialist’ ideas, we believe that ‘Quality-Sustainable Growth’ should remain the basis for any equity portfolio. Indeed, even on the long-term basis (for small minority of investors who still have flexibility of maintaining a longer-term outlook), this portfolio would deliver strong returns over exceptionally extended periods (including ultimate destruction of debt), although during shifts towards ‘socialism’, it is likely to underperform government connected and poor quality stocks.
5. Five, under almost any conceivable scenario, we believe that the US$ is likely to be stronger rather than weaker (indeed the more aggressive Japan, China and Eurozone become), the higher US$ is likely to go. Another asset class that we believe wins under almost any scenario (bar normality) is gold.
It will take more crisis to get us here but I agree that that is where we’re going. As for allocations, you can’t support both gold and commodities and the US dollar! It’s one or the other.
Heaven forbid this ever comes to Australia. The idea of Parliament House printing money for its pork is too much.
