Many experts are wary of high valuations and the meagre outlook for economic growth in the UK, but the manager of the £546m Liontrust Macro Equity Income fund thinks there are plenty of reasons to be optimistic.
Luthman (pictured) says that the scene is perfectly set for M&A activity, which will allow equity markets to re-rate without the need for high levels of economic growth.All this depends on a stable political backdrop, he says, as global companies will be less likely to invest if the outlook for economic policy is uncertain.
“Many people point to the fact that the outlook for economic growth isn’t great and therefore the outlook for corporate growth is poor. We’re saying that corporate growth can come from elsewhere,” he said.
“We are in an environment that is absolutely conducive for acquisition activity. There is a huge amount of liquidity, a desperate search for yield and very low borrowing rates, pretty much unlimited in size.”
“If a company’s cake isn’t getting any bigger, it will just take someone else’s slice. This is why we’re expecting earnings growth to be enhanced by acquisition activity followed on by consolidation.”
“It smells very similar to the back end of 2004 to me. There were big worries about low corporate earnings and margin compression as a result of stronger competition, but then there was a tsunami of acquisition activity. Low and behold, 2005, 2006 and 2007 were very good for markets.”
The FTSE All Share rallied almost 70 per cent between 2004 and 2007, before markets came crashing down during the financial crisis.
Performance of index 2004 to 2008
Source: FE Analytics
Luthman says that activity is likely to be strongest among large caps, and indeed his Liontrust Macro Equity Income and Liontrust Macro UK Growth funds are both heavily skewed towards the FTSE 100.
“Between 2004 and 2007 there was a lot of domestic activity in the FTSE 250. These companies are a lot more highly valued, which suggests it will come more on the large cap end,” he said.
Luthman says this positive scenario is very much dependent on the 2015 general election.
He says it is more likely that the Conservatives will get a majority rather than Labour, but he fears a deadlock is an increasingly likely scenario.
“The strength of sterling will keep acquisitions muted for the time being. Global corporates would want to see this ease before they engage, and they will also want some more clarity after the general election is decided,” he said.
“The Lib Dems have self-destructed and the likelihood of UKIP getting a load of seats in this country is low. It will be a two-horse race, and if it’s close run we could end up with a very weak government.”
“If there’s only five or 10 votes in it, the period of uncertainty will be negative for the exchange rate, and could put off a lot of global corporates.”
“It’s difficult to see acquisitions and markets shooting ahead if there’s a deadlock, but if we do see a majority for Cameron of more than 50, you could see big moves – particularly at the large cap end.”
Luthman’s optimistic tone is in stark contrast to many of his peers, with a number of multi-asset and equity managers upping their cash exposure in recent months.
However, the manager thinks that a sizeable chunk of the negative sentiment is as a result of geopolitical worries in Iraq, Syria and Russia, and says it is almost impossible to time the market on this basis.
“There are a lot of tensions in the world that have been building up,” he said. “Russia is an issue that has gone on longer than [co-manager of Liontrust Macro Equity Income], Steve Bailey expected.”
“We thought there would be a very quick annexation of the Ukraine, the rest of the world would huff and puff, and then everyone would go back to being good capitalists. However, it hasn’t played out that way.”
“The thing is, the world is always beset with tensions. They come and go faster and slower than what people expect. At the moment there are a few things going on, but it will pass. It always does.”
The geopolitical uncertainty has contributed to stuttering markets in 2014, though the likes of the MSCI AC World, FTSE All Share and S&P 500 are all in positive territory year-to-date.
Performance of indices in 2014
Source: FE Analytics
As well as acquisition activity possibly being a major driver of markets, Luthman points to two longer-term structural drivers that are much more predictable.
Both, he says, will see money flood into equity markets, thus boosting share prices.
“There are enormous amounts of money parked on the balance sheets of central banks,” he said.
“In a period of rising interest rates, we will see bond prices weaken – that’s just a basic principle of economics. If I was in charge of many billions of pounds of money, prudence suggests that at least some of this will go out of bonds and into other areas – whether that’s infrastructure projects or equity markets.”
“We’re already seeing it happening. Sovereign wealth funds including Norway are saying they are going to move into real assets and we expect more to continue to do so.”
Luthman refers to the wave of money that could be set to pour into equity markets as “the child of QE”.
He says it is unlikely that the Bank of England or Federal Reserve will lead the move, pointing instead to China and European countries such as Norway.
“If the Bank of England started flogging all of its gilts, interest rates would spike and the property market would collapse,” he said.
“However, other central banks don’t have that kind of loyalty to think about. Some, like China, own the debt of others.”
“In an environment like this, the place to be is where the money ends up.”
Luthman believes the trend from bonds to equities from central banks will be mirrored by many retail investors, but doubts whether institutional money will change hands.
Most of the biggest pension funds are defined benefit schemes, which Luthman says are forced buyers of fixed interest.
“Among retail investors, it seems to already be happening in the States. We’re seeing lots of warnings about bond markets in the UK, but it’s not happening yet,” he said.
“Given how bad liquidity is in certain areas, when the move comes it could be very difficult for bond investors.”
Luthman also points to the growing 48- to 64-year-old bracket in the UK, which will also see money flow into equity markets.
“This is the age you’re at your peak earning level. Their children are leaving home, many have paid down or paid off their mortgage, and many are also coming into some kind of inheritance,” he explained.
“This age bracket will be between 12 and 15 per cent higher in eight years’ time. Given these people have a 15- to 20-year time horizon, I’d expect the bulk of this to go into equities. If you are 50 years old, saving for retirement in bonds is inappropriate in my view.”
The effect will be further boosted by the increase in the ISA limit to £15,000 and the relaxing of pensions regulations, which will allow investors to take out lump sums at a younger age.
Luthman says wealth managers are likely to benefit directly from this phenomenon, which explains why this sector is one of Liontrust Macro Equity Income’s biggest overweights.
Jupiter Fund Management and Aberdeen Asset Management are both top-10 holdings.
For a bull market on the scale of 2004 to 2007 to occur, however, Luthman says that acquisition activity is the all-defining factor.
“The big risk for investors at the moment is not being in equity markets were this to happen,” he said.
Liontrust Macro Equity Income has clean ongoing charges of 0.86 per cent. It is a top-quartile performer over 10 years with returns of over 170 per cent.
A poor 2012 has seen the fund fall slightly behind its sector and benchmark over three years, though the last 12 months have been very strong.
Luthman and Bailey are among the very few overtly top-down managers in the IMA UK Equity Income sector, prioritising macro analysis above all else. They also run the £69m Liontrust Macro UK Growth fund.
