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The market has found itself in a “ridiculous state”, warns Bennett

05 October 2015

FE Alpha Manager John Bennett tells FE Trustnet how he will be positioning his portfolios given that central bankers are now trapped and the deflation bogeyman has “come home to roost”.

By Alex Paget,

News Editor, FE Trustnet

Equity investors face a very challenging environment as the ‘debt threat’ which has been building up for a number years is finally coming home to roost, according to FE Alpha Manager John Bennett, who warns that central bankers are now trapped and unable to stave off deflation.

In order to revive their respective economies and restore confidence within markets after the global financial crisis, central banks around the world have pursued very loose monetary policies such as quantitative easing (or money printing), ultra-low interest rates and currency devaluation

These policies have flooded the market with liquidity and have been among the major driving forces behind the rally in risk assets which has occurred since the market bottomed in March 2009 after the financial crisis.

However, due to a variety of macroeconomic headwinds coupled with high valuations, that rally has shown signs of stuttering in 2015 – as the graph below shows.

Performance of indices in 2015

 

Source: FE Analytics

Following the recent China-induced volatility, many experts have geared up for a rally in equities over the coming months as slowing growth in major parts of the global economy has decreased the likelihood of Janet Yellen and the US Federal Reserve raising interest rates.

However Bennett, director of European equities at Henderson, says this development is a very nasty one for risk assets as it shows that huge amounts of central bank intervention over recent years has done far more harm than good.

“For me, I think the debt threat is coming home to roost. Debt never went away in fact, in most places, it only got bigger. It is exactly that debt threat that keeps central bankers with the policies that they have been undertaking (i.e. QE) and keeps their feet to the floor.”

“Look at how Janet Yellen has found herself, in my view, cornered, trapped and unable to put up interest rates up by even 25 basis points. This is the ridiculous state we have found ourselves in and it seems to me that no central banker has come out and admitted to the lessons of history.”

“That is – money printing has never, never worked in the past. They are unlikely to admit that because they are singing a different tune and trying very hard to keep the show on the road. You are now seeing the desperation come in be it Janet Yellen feeling unable to put up interest rates at all or be it China joining the devaluation bandwagon.”

Bennett points out how central banks in the US, UK, Europe, Japan and now even China have raced to lower the value of their respective currencies – and there is one major reason behind it all.

“All of it is because of debt. Ever since the crisis, we continue to live with this horrible spectre of debt deflation,” he argued.

“We’ve flirted with deflation, we’ve flirted with negative bond yields and we have had another deflationary impulse come in to the world which equity markets have clearly reacted to and that, in my view, was China admitting it has problems.”

Bennett says the developments in China (such as its slowing growth and the recent devaluation of the yuan) are very deflationary in their nature and highlights that Chinese producer prices have been falling for some time now.


 

He warns this trend is likely to continue which will create a very difficult environment for equity investors.

“The deflation bogeyman was never far away and he is back in the room. This is an enormous challenge for equities and let’s see how central bankers respond. We’ve had the first hint of that with Janet Yellen in failing to clear even the first small hurdle of pushing rates higher.”

“My money is on QE4 and my money is probably on QE infinity. I think they are trapped.”

Many experts have warned about the threat of deflation to global markets given the huge amount of debt in the system, over-capacity in the economy and an ageing population.

Many of them also warn that it will lead to a debt-deflation spiral akin to the events which in folded in Japan during the 1990s – a period which has been dubbed the ‘lost decade’ due to impact deflation had on the country’s equity returns.

Performance of indices during the 1990s

 

Source: FE Analytics

Bennett doesn’t necessarily believe equities will perform as badly as that, but says a ‘regime change’ is underway in markets which will lead to clear winners and losers. The losers, he says, will be those areas which massively benefitted from the boom in emerging market equities and economies between the Asian financial crisis of the late 1990s and the 2008 crash.

“I do think the narrative that is going to play out, not just for the next six months, but for longer, is stagnation or recession in international trade and that is why I believe we have entered a lengthy bear market for capital goods.”

“A great number of capital goods companies had a very nice decade or more selling to an urbanising China, among others. The urbanisation of China doesn’t end, but you can see that the delta is no longer positive in terms of the rate of growth in demand from China for those goods.”

“That’s negative number one. Negative number two, and this is the double whammy, is the supply of capital goods in China and elsewhere in Asia will overwhelm some capital goods companies in the west. This is at a time when many of them were trading at high valuations and on multi-decade high margins.”

“I am a mean revisionist and I would look for negative mean reversion in the profits of what I would describe as internationally traded goods. What I’m saying is that the beneficiaries of the so-called super-cycle in resources and the second derivative beneficiaries of that face somewhat of a bust.”

The manager says there are a number of sectors which fall into that category ranging from miners, industrials and certain consumer goods companies – all of which performed very well during the last decade.

Performance of indices during the 2000s

 

Source: FE Analytics

As a result, the manager is underweight those areas within his Henderson European Selected Opportunities and Henderson European Focus funds.


 

He is, however, very positive on other areas of the market. His largest weighting is to the healthcare sector, for example, as like other managers such as Neil Woodford and Mark Barnett his is confident pharmaceutical companies will deliver high levels of growth due to innovations in the industry.

“On the other side of that, I think there are some winners. I still think we have entered a lengthy bull market in healthcare and also in data – how we use data and how companies harness data. These will be multi-year bull markets to offset the multi-year bear markets in the likes of capital goods.”

Also, in order to outperform, he says investors should focus on domestic orientated companies in the UK and continental Europe rather than those which generate the majority of their earnings overseas.

Bennett, who has run European funds at GAM, Gartmore and now Henderson, has beaten his peer group composite in 11 of the last 15 calendar years.

Performance of fund versus sector and index under Bennett

 

Source: FE Analytics

Over recent years, one of his best relative performers has been the £453m Henderson European Focus fund which he took charge of in February 2010. Our data shows it has been a top decile performer in the IA Europe ex UK sector over that time and has more than doubled the returns of its FTSE Europe ex UK benchmark in the process.

It has also beaten the sector and index in each calendar year since Bennett has been at the helm. 

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.