Investors should not forget that recent moves by the central banks to calm markets and stimulate the economy represent a further push into “uncharted waters” that could lead to the emergence of much bigger problems in the future, managers at Ruffer, Rothschild and Troy have warned.
Earlier this month saw the Bank of England react to the UK’s vote to quit the European Union by halving the base rate to a new historic low of 0.25 per cent, adding £60bn to its government bond-buying facility, launching a £10bn corporate bond-buying programme and unveiling a “term funding scheme” to help banks pass on the base rate cut.
The market reacted positively to the news – since the Bank’s announcement on 4 August the FTSE All Share has posted a 3.58 per cent total return. Since the Brexit referendum, the index is up more than 9 per cent and is currently trading above the 6,900 mark.
However, Ruffer Investment Company managers Hamish Baillie and Steve Russell are maintaining the £353m trust’s cautious positioning because of the heightened uncertainty created by events like Brexit as well as the suspicion that ultra-loose monetary policy is approaching its limits.
Performance of trust vs sector over 10yrs
Source: FE Analytics
“At the moment there is little more of use that can be said on the potential impacts of Brexit, beyond the notion that monetary policy is set to remain extremely loose, as shown by [the] moves by the Bank of England,” they said in their latest update.
“That said, we can draw at least three conclusions from recent events. First, politics, and perhaps populism, are set to play a greater role in setting the economic agenda than they have for many decades, and not necessarily for the good. Secondly, as if sensing this, politicians are already moving away from austerity towards more fiscal interventions, with likely implications for inflation and real interest rates.”
“Thirdly, at least for now, ever lower interest rates can still paper over the widening cracks appearing in underlying economies. The first two observations could hold true for some time, the last, we fear, could prove to be illusory.”
As a result, Baillie and Russell have kept their defensive strategy “almost entirely unchanged” in spite of the Brexit result and the wave of stimulus that followed. Their trust currently has “just sufficient equities to get by” (with its largest allocations to Japan and the US) and around 45 per cent in index-linked bonds that they think will be invaluable when negative real interest rates “really start to take hold”.
The team behind RIT Capital Partners – which like Ruffer Investment Company is another investment trust that has capital preservation at the heart of its approach – has made sure that the portfolio is positioned to protect investors against future shocks.
Performance of trust vs sector over 10yrs
Source: FE Analytics
In a recent review of the six months to the end of June 2016, chairman Lord Rothschild said: “The six months under review have seen central bankers continuing what is surely the greatest experiment in monetary policy in the history of the world. We are therefore in uncharted waters and it is impossible to predict the unintended consequences of very low interest rates, with some 30 per cent of global government debt at negative yields, combined with quantitative easing on a massive scale.”
“To date, at least in stock market terms, the policy has been successful with markets near their highs, while volatility on the whole has remained low. Nearly all classes of investment have been boosted by the rising monetary tide. Meanwhile, growth remains anaemic, with weak demand and deflation in many parts of the developed world.”
These conditions mean that Lord Rothschild stands by the warning he gave in his 2015 review, when he argued that “we may well be in the eye of a storm” and returns will be much harder to come by. Indeed, the Brexit result in the UK, an “unusually fraught” US presidential election, slowing Chinese growth and the spread of terrorism to parts of Europe and the US have compounded these concerns.
As a result, the £2.8bn RIT Capital Partners trust has been reducing its quoted equity exposure in recent months to protect the portfolio. At the same time, it has been increasingly its exposure to assets seen as less risky, such as absolute return strategies, credit, gold and other precious metals.
These warnings follow the cautious note from Troy Asset Management’s Sebastian Lyon, who recently argued that valuations in many parts of the market are “divorced from reality” and said investors should not think the calm created by central banks will last forever.
Lyon, who runs the £3.2bn Trojan fund, said: “Low interest rates and quantitative easing have led to ballooning asset prices. Over $12trn of government bonds now offer buyers a negative nominal yield. This is not even an example of ‘picking up pennies in front of a steam roller’. Instead, it is throwing your own pennies in front of one – courting danger with the deliberate intention of losing money.”
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
“We repeat our warning that in an environment of near-universally overvalued asset markets it is unlikely to be easier to navigate the post-market falls than to avoid the falls themselves. This is because, with both equities and bonds looking vulnerable, traditional asset diversification may not protect to the same extent that it has in the past.”
To end with one more bearish commentator, Hawksmoor Investment Management head of research Jim Wood-Smith is another investor that has been persistent in warning that the liquidity-fuelled rally since the financial crisis is leading to worrying distortions in the market.
“There is just something terribly wrong with the way markets are behaving. It is diabolic. Bad has become good. The threat of economic hardship makes central banks create more money. More money means lower bond yields, even if they are already less than zero. And if bond yields are zero, then it now appears so should equity yields,” he said in an update this week.
“My logic says that if the economy is really so bad that zero gilt yields can be justified, then the outlook for dividends is terrible. And if that is true, I want some compensation for my risk. That in turn comes from getting some dividends, not pricing them at infinity. Not only is the logic of the market utterly scrambled, neither does it appear to be based on fact.”
“I seem to be saying the same few things each week now. That is no good for those who are loyal or foolhardy enough to keep reading. But these markets are unbelievable. It gets even worse though: for those few companies prepared to admit that life, for whatever reason is quite tough, are rewarded by having their share prices mushed. The market is demanding earnings growth, but rejects the economic conditions to support this.”
“It cannot last. It is massively unhealthy and central banks should stop pandering to it. They are like meadow pipits frantically feeding the monstrous cuckoo in their nest, terrifyingly ignorant of the inexorable course of events.”
