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Investment views

Central banks brought into focus

21 June 2019
Author: John StopfordHead of Multi-Asset Income

John Stopford discusses global markets and the reaction to moves from both the European Central Bank and the US Federal Reserve.


Lindsay Williams: Central banks are sharply in focus this week because of various pronunciations from: (1) Mario Draghi; and (2) the US Federal Reserve. On the telephone now to talk about this is the Head of Multi-Asset Income at Investec Asset Management in London and that is John Stopford.

John, I think the Mario Draghi statement a couple of days ago really came as a bolt from the blue and it really set the markets on fire. There were a couple of other things that set the market on fire as well but it really set the tone for the rest of the week and central banks, as I said, sharply in focus again.

John Stopford: Yeah, it is reminiscent of what he did 7 or so years ago. You know they would do whatever it takes. I mean certainly you get a sense that he is quite keen to ease. How keen his colleagues in the ECB are, and his term as Head of the ECB is coming to end, it will be interesting to see but he is essentially forcing the hand I think of the committee. If they don’t ease on the back of the comments that he made, I think the market could take it quite badly.

Lindsay Williams: Yes. When is the next ECB meeting, in other words the validation of what Mario Draghi said at that press conference?

John Stopford: So they meet on a sort of regular cycle every month or so, just over a month. Yeah, so they have got a variety of tools. I think what he was trying to emphasise was that they aren’t powerless, that even though rates are negative and whatever and they have already done a lot of QE, that there is more they can still do.

I think it has set the bar for what the market is now expecting and, clearly, generally central banks I think have been worried by how markets took things in December last year, the ongoing sort of trade war, the poor data and generally inflation tending to be relatively weak. There are lots of reasons but certainly the extent to which they have upped the ante in the last few days is pretty marked.

Lindsay Williams: Yes, it really is and it wasn’t that long ago that you and I were talking about the fact that the quantitative easing programme that has been initiated or had been initiated by the European Central Bank for many years was being curtailed or being pulled back and now suddenly they have done, as the US Federal Reserve has, a complete U-turn. Does that tell you that they know something that we don’t; in other words, the European economy is in deeper trouble than even the German manufacturing numbers tell us?

John Stopford: I mean the data has been pretty lousy and I think it does, particularly if the trade environment remains tricky, open up potential for this to feed on itself. Confidence has taken a hit. People’s willingness to invest has taken a hit. So lots of weak data.

I guess what is surprising is just how quickly central banks have turned around. People are used I think to them being sort of super tankers and changing their language relatively slowly and this time around it has been notable how quickly we have gone from pricing in tightening in the US to easing and also the extent to which the ECB have moved away from indicating that the next move in rates ultimately would be up to now talking about rate cuts, talking about potentially tiering of deposit rates, talking about additional QE and so on.

So there is suddenly a sense of urgency from central banks and clearly part of that is fear that they don’t want this – they want to get ahead of markets and get ahead of economic developments rather than be playing catch-up.  There is a sense that they have to some extent been pushed by bond markets, particularly if you look at the US market and to some extent the European market but just the extent to which the market moved ahead of the Fed to begin to price in a reversal in policy and rate cuts. I think to some extent they needed to validate that rather to avoid markets reacting badly to them being too slow, too complacent.

Lindsay Williams: In the 1970’s in the UK there was a series called Ever Decreasing Circles and I would like to say that there is now an ever-decreasing cycle in monetary policy because, as soon as there is some sort of potential crisis, the central banks come in and say right, let’s cut rates and let’s re-initiate QE. Do you get that sense as well?

John Stopford: Yeah, I mean in some ways it is extraordinary. You know we are at very low, decade-low, record levels of unemployment in the US, for example; inflation is a bit lower than target but not massively; growth has been very strong relatively, and yet rates are peaking well below where the Fed thought they were going to peak and now probably it would be very surprising if they weren’t now on their way down. In the case of Europe, we haven’t seen any policy tightening. We have just seen an end to QE and rates on hold and now we are moving back into an easing cycle.

So it is slightly scary in that there is not a lot of ammunition, however much they might want to talk up what is available. In previous downturns, they have needed a lot more than they have currently got. Clearly, they are trying to avoid a downturn by being somewhat pre-emptive but it is going to leave them with very little left in the locker next time we move into more of a global recession.

Lindsay Williams: As we speak, John, the S&P Futures Contract is showing an all-time record high for the S&P 500. Should the Futures stay here when the market opens in an hour-and-a-half or so’s time, it is melting up.  Do you think this is sustainable?

John Stopford: I think in the short term the market is focussed on the sort of sugar rush and the good news and I think investors, if you look at surveys, have been pretty cautiously positioned. So people got frightened very last year.  They participated a bit in the rally earlier this year and then have become quite cautious again, not least on the back of Donald Trump putting renewed pressure on China, threatening tariffs on Mexico and so on.

So I think you have got a positioning environment where markets can squeeze higher and then you have got a number of sort of positive catalysts.  So this policy about-face by central banks potentially recreates the sort of equity market put or equity market underpins the expansion and then Donald Trump saying he is going to meet President Xi and talk about trade gives some hope of some sort of deal there. I think all the market is really focussed on is that sort of shorter term some of the risks have been removed or looks much better.

Whether actually rates cuts are timely enough in an economy that is already slowing down, whether they have got enough ammunition, whether Trump and Xi will do anything substantive or whether it will just be noise around a deteriorating relationship between China and the US, I think those things are things that the market will worry about later.  In the short term, potentially we can go a bit higher just on people not being particularly long equities and suddenly the environment looks a bit rosier for a while.

Lindsay Williams: As Head of Multi-Asset Income at Investec Asset Management, what do you do? Because of the continuing flip-flop nature of the monetary policy of the central banks, do you have to also flip-flop yourself when it comes to portfolio management? What are you doing? How are you positioning yourself?

John Stopford: I mean, the sort of big picture, we have been incrementally cautious over the last sort of 12-18 months. We think we are late in this cycle. We think growth and earnings are under significant pressure. Valuations are not really very compelling. I think there are tactical opportunities around that to either add some risk back or take risk off but for us the bigger picture is it is pretty late in the day to be backing big upside in equities and now, clearly, there is also quite a lot priced in in terms of bond markets as well.

So I think the opportunity set is looking a little bit thinner and it probably doesn’t pay to be particularly heroic. Yes, potentially take some tactical advantage of what is going on but be quick to take profits into rallies and maybe look to add a little bit into sell-offs but not get carried away.

Lindsay Williams: So you are sceptical of the current rally we are seeing in certain asset classes. When I say “certain asset classes”, when I look at my S&P 500 Futures screen, I mean the equity asset class.

John Stopford: Yeah, I think it is late cycle. This is the last innings I think for the equity market unless something radically changes. The global expansion is long in the tooth; margins have expanded a lot; corporate leverage has picked up; growth is under a lot of pressure; you have got a global economy that is deglobalising, unpicking relationships between countries, across borders, and so, yes, we think it is a challenging environment and to assume that it is all plain sailing from here is probably a bit optimistic.

Having said that, that doesn’t stop equities doing reasonably well maybe over the next 3, 6, even 12 months but I think we would just tend to tactically go in the opposite direction. When you see a decent rally, look to pull in your horns a bit and when you see a sell-off maybe add a bit but against a backdrop of being ultimately sceptical that this is the beginning of a new bull market rather than the end of one that already looks quite long in the tooth.

Lindsay Williams: John Stopford, thank you so much for your time. John Stopford is the Head of Multi-Asset Income at Investec Asset Management in London.

John Stopford
John Stopford Head of Multi-Asset Income

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