Spiller has become increasingly bearish on the global economy and financial markets due to the huge levels of debt in the system.
He says such levels of debt are a result of central bank intervention, which has been a common feature of the past 20 years or so as the likes of the US Federal Reserve have continually eased monetary policy without tightening it back up again.
However, Spiller says the situation has worsened considerably since the last financial crisis as in order to revive the economy, central banks around the world have cut rates to zero and implemented huge amounts of quantitative easing (QE), which has artificially driven up the prices of bonds and equities to unsustainable levels.
Performance of indices since Jan 2009
Source: FE Analytics
Give current high valuations, Spiller thinks the next decade is going to be incredibly difficult for investors.
“Markets are enormously distorted. In our view, there is no asset class out there that will make a positive real return over the next 10 years. We can make that statement with certainty for bonds, but we believe it is generally true across all other asset classes,” Spiller (pictured) said.
“It is very different from the equity market peak in 2000 because then some parts were driven to absurd levels while others were really cheap. Now, there is nothing [that is cheap] on our valuation basis.”
While Spiller says it is all too clear to see that bonds will only lose investors’ money over the next 10 years – given that 10-year gilts now yield just 1.5 per cent – he says share prices have been forced into a similarly dire situation as a result of central bank intervention.
“Equities have been driven to levels which look pretty reasonable in the current interest rate environment so when I say returns are going to be very poor in the next 10 years, that is assuming interest rates normalise, the economy recovers and inflation returns at some stage over that time.”
“We do not think the current valuation levels in equity markets can be sustained.”
The principal reason why Spiller is so bearish is due to the huge amount of debt in the system, which he says can only be sorted out by higher inflation – but his has recently fallen to 0.5 per cent in the UK and is in negative territory in the eurozone.
In his presentation, the manager highlighted a study conducted by the McKinsey Global Institute which looked various historic deleveraging processes after debt to GDP was at extremely high levels in the past.
It shows the best path is if an economy grows out of its debt, but that has only happened once before when the US economy picked up due to European rearmament prior to and during the Second World War.
Another option is “belt tightening”, when a government or central bank devalues its currency by increasing exports like was seen in Finland and South Korea in the 1990s. However, Spiller says that path won’t work if the debt problem is a global one like it is today.
The study shows that, without those two paths, it leaves either high inflation or massive defaults to ‘fix’ the debt problem. However, Spiller says it is inconceivable that developed market central banks would allow a huge depression to sweep their economies and therefore he says high inflation is the only option.
He also thinks that, even without the results of the McKinsey Global Institute’s study, much higher inflation is an inevitable outcome anyway.
“Obviously, central banks don’t want deflation and when they ran out of interest rate cuts they imposed QE. The theory of QE is that you print money, buy assets of the private sector which re-liquefies the private sector and the economy gets going,” he said.
“Then – this is the critical bit – you buy sell those assets back. If you can achieve that second part, there shouldn’t be a huge inflationary consequence. The key question is, will central banks be able to complete that second part without causing a depression? Our bet is that they can’t.”
“Even worse, if inflation gets going, they are unable to raise interest rates very far to curb it because of current debt levels. Studies have shown it would cause huge problems in the real economy and the banking sector.”
There is no doubt that many experts don’t share Spiller’s views on inflation, as many have pointed to issues such as a lack of bank lending growth and spare capacity in the global economy as reasons why it should stay lower for longer.
Performance of indices in 2014
Source: FE Analytics
They also point to the lower oil price, which fell 44 per cent last year and currently stands at $57 barrel, as another reason why inflation and interest rates will stay low.
However, Spiller says all these issues are only short-term factors and investors are therefore naïve if they believe they will continue to keep inflation low.
“In the short term, commodity prices have come down, we have had a good harvest so food prices have come down and we all know about the oil price – but these are all one-off events.”
“Although bond markets are telling you there is never going to be inflation again, if we continue to get growth in the Anglo-Saxon countries, it is likely that wages start to respond as unemployment levels are low – that’s when we will find out whether we are right on inflation.”
Given his concerns, Spiller says his Capital Gearing Trust is the most the defensive it has ever been since its launch in 1982.
He currently holds 30 per cent in cash, more than 30 per cent in index-linked bonds – which he expects to be the only area of the market which will offer him protection over the next 10 years – and around 30 per cent in selected investment trusts which he hopes will eke out value over time.
Our data on Capital Gearing spans back to January 1995 and, according to FE Analytics, it has returned 679.55 per cent since then, beating the FTSE All Share by more than 310 percentage points.
Performance of trust versus index since Jan 1995
Source: FE Analytics
Spiller says he runs the portfolio as if it were his own personal savings and therefore he prioritises downside protection.
That is borne out in the numbers as the trust has had a maximum drawdown, which measures the most an investor would have lost if they had bought and sold at the worst possible times, of just 15 per cent over the last 20 years.
As a point of comparison, the FTSE All Share’s maximum drawdown over that time is close to 50 per cent.
In more recent times, Capital Gearing delivered a 3.2 per cent in the falling market of 2011 when the European sovereign debt crisis intensified and a further 4.72 per cent during the crash year of 2008 when global equities fell more than 20 per cent.
It is currently trading on a 2 per cent premium to NAV. Although may not look overly attractive to investors, it has regularly traded on a double-digit premium over recent years due to Spiller’s track record of protecting capital.
The trust isn’t geared and has ongoing charges of 1.26 per cent.
