The nonsensical investor mind-set that has been heavily weighing on markets is finally starting to lift in time for the new year, according to Neptune’s Robin Geffen (pictured). 
The CEO and manager of several funds at the firm, says “the world has changed” since controversial Republican presidential candidate Donald Trump won the US election in November.
While this has indeed increased levels of uncertainty across markets globally, he is upbeat that a marked change is happening in markets, which can be shown through the recent uptick in bond yields.
He believes this has been sparked by a strengthening US dollar, promises of fiscal loosening and the increased potential for global growth feeding through to investor sentiment.
“The world has changed since 8 November. Who knows how Mr Trump’s presidency will unfold but, as investors, we’d emphasise one important development already underway – the electrotherapeutic shocking of the investment community out of a stale and pessimistic collective mindset that has dominated during the past few years, but which we believe has made no sense at all,” Geffen said.
The CEO says the increasing popularity of mega-cap, dividend-paying stalwarts or ‘bond proxies’ during the first half of the year was caused by the contagion of fear surrounding economic prospects across the globe. While this of course pushed valuations to historically high levels, he says investors continued to buy into the assets in what he describes as a “morbid groupthink”.
Geffen says this same behaviour led to bond yields reaching historic lows as more and more investors bought into the asset class, despite the fact they returned little capital and paid precious little income.
Performance of indices in 2016
Source: FE Analytics
“If one thing characterises the morbid groupthink of recent times, it is the inexplicable demand for bonds and bond-like assets despite their truly pitiful returns. At the same time, historically low bond yields have fed the gloom of investors: ‘Larry Summers can’t be serious that growth is over, can he?’, ‘Well, perhaps, just look at those yields!’ No more,” he said.
“Bond yields are on the rise. The US 10-year government yield has risen from less than 1.4 per cent in July to 2.5 per cent today, accounted for by all components: rising growth expectations, rising inflation expectations and a rising term premium.”
“The Fed tightening cycle is back in play. Pre-election, futures were pricing in a Fed funds rate of less than one at the end of next year; now they’re pricing about 1.75. And whatever Mr Draghi says, the ECB just tapered QE.”
Geffen points out that many people now believe an interest rate target increase from central banks can increase inflation and growth, which is controversial given that cutting rates has historically been associated with boosting inflation.
While this may or may not be the case, he says it is an interesting debate and one which demonstrates a distinct change in thought process since the financial crisis – another reason, according to the manager – behind irrational market behaviour over recent years.
“We’re not ripping up our textbooks, but do believe that amid rudderless soul searching during the post-crisis era, investors and even policy makers have peered deep into the distorted mirror of the markets for the answers,” he continued.
“That was foolish and surprise, surprise, now that yields are rising, there is an almost audible collective sigh of relief. When yields rose quickly during the Taper Tantrum of 2013 the VIX index shot up, indicating distressed inventors. But as yields have risen rapidly since the US election, the VIX is down.”
Performance of index over 10yrs
Source: FE Analytics
Geffen says economic fundamentals were actually supportive of a strengthening US dollar and higher yields before the result of the US election was announced.
He says that underlying inflation in the US has risen by 40 basis points over the last year to 1.7 per cent. Geffen also points out that global PMIs (which indicate the health of manufacturing sectors) have been strong for months.
“Last December’s Fed hike uncovered vulnerabilities in US credit markets and China. But outside of the energy sector, corporate debt ratios are low and with oil back up at around $50 a barrel, helped recently by long-awaited OPEC production cuts, the credit markets have de-coupled from the Fed and dollar,” he said.
“So too has China, due to the de-pegging of its currency from the dollar. An active Fed and a strong dollar are not the problem they were [facing] this time last year. This is evident in the only modest tightening in overall financial conditions that has accompanied this December’s Fed hike compared to last December’s, as captured by the Goldman Sachs US financial conditions index, for example.”
The manager says that Trump and the Republicans controlling both the House of Representative s and the Senate are likely to agree on tax reforms, cuts and de-regulation – all of which are pro-growth.
Another positive economic factor which could boost markets, according to Geffen, is the depreciation of the Japanese yen, which has happened as a result of rising yields across the globe.
Because the Bank of Japan pegs 10-year yields on Japanese government bonds at zero, he says Japanese equities now look particularly appealing.
“We believe that there is a lot to like about Japanese equities given domestic policy support and corporate reforms. Global macro, which spoilt the picture earlier in the year, has now turned supportive,” he concluded.
“Political risks loom on the horizon in Italy, France and Holland, and worries over the future of the European Union are likely to result in volatility next year. That said, in our view globally the opportunities for returns outweigh the risks. For now, we believe you should be in the market.”
Since the turn of the millennium, Geffen – who manages both Neptune Global Equity and Neptune Income funds – has returned an average of 174.81 per cent compared to his peer group composite’s return of 113.82 per cent over the same time frame.
Performance of Geffen vs peer group composite since 2000
Source: FE Analytics