Consensus views surrounding China, Trump, the UK and the overall strength of the global economy are inaccurate, according to star manager Neil Woodford (pictured), who warned markets could well be making a mistake in how they’re behaving at the moment. 
As such, he said there are valuation anomalies he is aiming to exploit as markets undervalue UK domestic-facing stocks and overvalue stocks deemed to benefit from a global reflationary trade.
These views come as the first part of our exclusive ‘Woodford Week’ series, which will focus on the manager’s views, philosophies and his investment vehicles themselves, between now and Thursday.
“I think it is a consensus view that the world economy is in a very safe place and it’s a safe place to assume that: growth will continue to be relatively strong; that China will carry on investing in infrastructure; that [Donald] Trump will somehow engineer rapid growth in the US; that interest rates are going to carry on rising in the US; that policy is normalising and it’s normalising because growth is coming through and inflation is going to tick up,” Woodford explained.
“The other consensus view is that the UK is a very challenged economy because of Brexit and because of political uncertainty. At the moment that’s what people are focused on, and they’re manifesting those views by overvaluing some stocks, and equally undervaluing others.”
One macro view the manager feels particularly strongly about is China’s credit-fuelled infrastructure spending, which he warned is unsustainable and could lead to a more challenging road ahead for the country than many investors expect.
Equally, he believes Trump is far less likely to bolster US growth than the consensus thinks, despite the fact last year’s so-called ‘Trump trade’ – when markets rallied due to Trump’s proposed fiscal stimulus – has already snapped back year-to-date.
Performance of indices in 2017
Source: FE Analytics
“I think the consensus view has made a mistake with respect to the US,” Woodford said. “What I said when Trump was elected – and I’ll say it again now – is that the checks and balances in the US political system will ensure that what Trump had promised on his road to the White House was going to be virtually impossible to implement, and so it has transpired."
“I was pretty convinced that Trump would not be able to engineer a healthcare reform on the scale he had promised, that he would not be able to execute his tax cutting and fiscal spending plans at all and arguably his trade policy agenda – which I thought had a greater probability of coming to pass because it is more vulnerable to executive order – seems to have faded away as well.
“Apart from anything else, Trump hasn’t actually got an administration. There are hundreds of vacancies in all the state departments because he hasn’t appointed anybody – partly because nobody wants to work for him.
“So, we have a completely ineffectual president who is putting his focus on Twitter communication and isn’t actually delivering what he talked about on the campaign trail. I think people believed him and embedded their expectations into stock prices.”
Turning to the domestic economy, Woodford’s thoughts on the UK are well-known. As covered in his blog post at the start of the month, he explained that investors have become too bearish on UK domestics due to heightened political uncertainty stemming from Brexit negotiations and Theresa May’s failed bid for an outright Tory majority in Parliament.
“I know people are worrying about whether we have an effective government, whether [May] can command a majority with the DUP. My view is that she will be able to command a functioning majority – obviously some concessions will have to be made to the DUP – but I think it would be wrong to abandon hope on the domestic economy as a result of Theresa May’s political problems,” the manager reasoned.
“I understand the media’s obsession with Brexit and the media’s obsession with politics as they’re important issues but, in the real world, we rock up to work each day and we all get on with the business of doing what we do.
“The reality is that there are record levels of employment in the UK, there are record levels of job vacancies in the UK and our exporters and manufacturers are performing particularly well because of the fall in currency last year.
Performance of currencies over 1yr
Source: FE Analytics
“Inflation really hasn’t been the problem that people thought it would be in the wake of the Brexit vote, interest rates are likely to remain very low and fiscal policy will, if anything, be more stimulative than it otherwise would have been as a result of political changes. And, by the way, I think a soft Brexit is now much more of a likely outcome as a result of what has happened.”
At the margin, he therefore believes domestic-facing stocks look very cheap in a market where valuations have otherwise risen to historically high levels. He also said investors are wrong to assume we are near the end stages of a market cycle so should therefore avoid holding cyclicals.
“When people use the word ‘cycle’, what they’re trying to tell you is that somehow the economy is going to behave in a predictable way. And it’s going to behave in a predictable way rather similar to the way it behaved before,” Woodford argued.
“The notion that you can predict what is going to happen to the economy based on this rather repeatable pattern of growth, inflation and interest rates, is total rubbish.
“We’re in a very different economic world than the world that I lived through during the 1980s and the 1990s and indeed in parts of the 2000s. Since the financial crisis, growth has changed, global demographics have changed, interest rate policy and the relationship between rates, labour markets and inflation has changed dramatically.
“We are living in unprecedentedly interesting, but very different, economic times. So the notion that we’re early, late or middle cycle is bogus claptrap.”
Rather than take a macro view based on economic cycles, Woodford said the key long-term themes that take precedent for him on a global basis are deflation, demographics, high debt levels and dwindling productivity.
He therefore believes it is wrong to assume we are late in the economic cycle and that inflation will subsequently start ticking up and interest rates will rise.
In fact, he expects the US to only raise rates once or twice before stopping, while he doesn’t think the UK will raise interest rates at all over the next two years.
“The economy is not able to sustain a monetary contraction. Monetary conditions are not just a product of interest rates, bank credit and the level of indebtedness,” Woodford reasoned.
“Small increases in interest rates, along with other things such as dollar strength and an absence of the repeat of Chinese liquidity injection, can have quite an important impact on monetary conditions.
“The world economy is quite fragile in that respect. It’s not able to sustain much higher interest rates, not least because the volume of debt is so much bigger now than it was before.”
Aside from avoiding the temptation to monitor market cycles, Woodford urged retail investors to remain vigilant when it comes to valuations – a discipline he believes is not focused on enough by the industry.
“Often, if I pick up any document that is designed to communicate an investment message to retail investors, it is very unusual to see any commentary on valuation,” he pointed out. “It tends to be about how exciting specific businesses are or how terrible they are, or that the economy is going to hell in a handcart.
“The valuation overlay tends to be ignored. My message to retail investors would always be that valuation is the discipline you need to have visibility on and make judgments about, always.”