Investors are failing to recognise the true health of the global economy and, despite bearish sentiment, the market is full of exciting growth opportunities, according to Henderson Global Investors manager James Henderson (pictured).
On the other hand, Aberdeen Asset Management’s Bruce Stout warns that today’s economic backdrop is unrecognisable and that it has led to overly optimistic valuations across equity markets.
It is no secret that the macroeconomic and geopolitical backdrop of 2016 has been challenging for investors. From a geopolitical perspective so far this year, markets have experienced the UK’s shock EU referendum result, the election of controversial Republican candidate Donald Trump in the US and the general surge in populist parties across Europe.
Meanwhile, from a macroeconomic perspective, we have seen ultra-low interest rates, the continuation of quantitative easing and negative bond yields as investors intensify their hunt for income.
It is perhaps surprising, then, that this has had a limited impact on market behaviour. Year-to-date, the MSCI AC World index is up 26.92 per cent, which is the highest annual return it has achieved in more than a decade.
Performance of index over 10yrs
Source: FE Analytics
Stout, who manages the £1.5bn Murray International trust, warns that today’s market environment is entirely unparalleled and, as such, investors should remain cautious on seemingly unfazed markets and focus on capital preservation above anything else.
“There is nothing recognisable about the backdrop,” he said. “Younger people here today probably think that this is normal, that you pay a government for the privilege of borrowing your money. It isn’t, it’s meant to be the other way around.”
“You probably think that it is normal that when you put your money in a deposit account you get nothing, but there’s nothing normal about that and what happens when things like that prevail for a long time is that it basically distorts economics.”
“It prevents the official allocation of savings and investment and of course it comes about from a set of circumstances that none of us have seen before and that is the enormous build-up of debt at all levels of society – in the government sector, the household sector, the corporate sector, the private sector.”
“And unfortunately debt by definition is deflationary and unless you write it off, and unless you pardon it, then unfortunately it has horrible economic consequences for the level of growth rates that can be achieved and the opportunities that can be achieved by the next generation.”
The manager warns that this backdrop has “huge implications” for capitalism because, if companies are artificially kept alive through loose monetary policy, free market economics is unable to work.
Stout says this is vital for markets because it allows poor quality companies to go out of business and strong companies to survive.
“When you allow the ‘walking dead’ to exist in perpetuity, they price below the cost of the product in order to get cash flow in the door, in order to keep the lights on,” he continued.
“That’s what forces down prices in industry in manufacturing, in services, in retail, and it has also happened at a time when technology has come to a point where the information we have is so great that we continue to force downward pressure on pricing.”
“Now when we look forward and try to predict the unpredictable, we have no idea where interest rates will go, we have no idea where growth rates will go, we have no idea where the political environment is going to evolve. What we do know is that the debt margin that we all carry is not going to disappear and therefore the consequences of it still have to be dealt with from a global perspective.”
“Should interest rates rise, should inflation rise, then we are confident in saying these consequences are going to be even greater than they are at the moment. Because a rise in interest rates will create even more onerous debt-servicing commitments.”
As such, he believes investors should now focus first and foremost on capital preservation, despite the fact it is becoming increasingly harder to achieve.
“Bond markets are completely wrecked,” he explained. “They have been wrecked by QE, by governments buying corporate and government bonds regardless of credit quality. So if the bond markets are wrecked, and if equity markets are up because people can’t make money in bonds, then you have to be very wary of valuations.”
In stark contrast, FE Alpha Manager James Henderson – who runs a number of investment trusts including Lowland Investment Company and Law Debenture Corporation – says the global economy is in better health than ever.
He also believes this positive backdrop is allowing new and innovative companies to thrive, therefore offering investors numerous growth opportunities.
“I went to Berlin two weekends ago and I hadn’t been for 10 years. This time I went with just my phone. The time before I had to take a camera, a diary, a calculator, this time I took one phone,” he said.
“This time when I went there were a few more hotels, not many. But actually, because of the likes of Airbnb, it meant there were 20,000 more bedrooms available.”
“Actually, Berlin is infinitely nicer than it was 10 years ago, everything is better, yet I’m told that Europe isn’t growing.”
“It’s just not true, Europe is actually a much better place than it was 10 years ago, we just haven’t recorded the growth. You don’t need a camera so Kodak goes bust. It doesn’t actually matter that fewer cameras are produced because we have a phone in our pockets. We’re not recording growth properly.”
Henderson says the fact technological change has driven prices down for the end consumer is actually a positive for markets. While Stout believes this has resulted in a large proportion of so-called ‘zombie companies’, Henderson argues that it is actually encouraging people to spend money on services which don’t need a significant amount of capital to thrive in the first place.
“I think capitalism is actually working really efficiently. What has happened is the lifecycle of companies is getting shorter because they’re capital-light, they don’t need the capital they needed before,” he explained.
“When people moan and say there is no capital spending going on, it’s because the models of the companies have changed. There’s a lot of research and development and that has been missed.”
Some could argue that, as populations age and technological change pushes a number of companies out of the marketplace, employment levels could be negatively affected and the health of the greater economy could therefore take a hit. However, Henderson points out that job creation has never been greater and unemployment levels in the likes of the US are at record lows.
US unemployment rate since 1948
Source: Trading Economics
“It’s the same as companies – the lifecycle of jobs has shortened. I’ve sat at the same desk for 31 years now and my kids won’t do that. They will stay in a job for six or seven years and they will have to retrain because everything is developing faster.”
“So there won’t be the jobs for life, you won’t sit at the same desk as I have. It will be a much more fast-changing world out there, but there is a lot of job creation.”
“Yes, people are unhappy, but people are always unhappy. It’s the way of the world.”
While populations are indeed ageing, the manager says that net immigration has prevented the global economy from stagnating. He also says the “new economy” won’t lead to high levels of unemployment and, despite the fact consumer patterns are changing, the consumer sector is indeed still growing.
“We’re not consuming the same things at the same amounts, we’re consuming things differently. What we have to try and do is notice a little bit of this change that’s going on,” Henderson reasoned.
“So I’m not so obsessed with capital preservation, what I’m obsessed with is growth. If you get just one [company like] FeverTree, it makes up for a hell of a lot of mistakes.”
“What I’m trying to do is grow capital by taking some risk and, if you do that, you then get dividend growth over time.”
To achieve real dividend growth amid the changing investment landscape, the manager says it is key to focus on a company’s ability to grow its capital which, in turn, will result in dividend growth.
If investors aim for dividends outright as opposed to seeking capital growth first and foremost, he warns they can fall into the trap of buying “yesterday’s companies” which have high yields for a reason.
“It’s this fast change that is happening under the surface that economists just aren’t picking up. I agree with Bruce that interest rates are too low – interest rates are trying to push that GDP number up but it’s yesterday’s debate,” he concluded.
“For me, I’m looking forward to next year. I think the changes are very real in the economy, I thrive on all the doomsday stuff in the papers.”
“Yes, there is Trump and all the rest of it but this new dynamic, younger economy isn’t about old politicians pontificating, it’s not about economists causing trouble, it’s about a generation of businesses that are run by people that are actually very international about how they look at things and will be some big names going forwards.”