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Investment views

The last hurrah?

12 June 2019
Author: Philip SaundersCo-Head of Multi-Asset Growth

Lindsay Williams and Philip Saunders ponder the significance of the rally in equity markets amidst global growth concerns and talk of trade wars. Interview recorded on 7th June 2019.


Lindsay Williams: With me now is Philip Saunders, who is the Head of Multi-Asset Growth at Investec Asset Management in London. Philip, the working title for this podcast is “the Last Hurrah” and the reason I wanted to talk to you was because last night in the United States of America the Dow Jones rallied suddenly. After a terrible May, it rallied by 500 points plus in one day; the S&P vaulted its way through 2800; the NASDAQ got back all the losses that it incurred last week because of anti-trust measures against Alphabet, the parent of Google, etc., but I just wonder if this is the last hurrah because it smacked to me of the bears throwing in the towel and that usually means that something is going to happen and I notice that the S&P, having been up 20 points as we pre-record this interview this morning, is now only up round about 6 or 7. It has got a funny feeling about it. Am I being too fanciful?

Philip Saunders: No, I don’t think you are being too fanciful. I think that we have obviously seen what we saw, a strong rally since the beginning of the year than we have seen since the sort of quite vicious setback as sort of expectations of sweetness and light on the trade front basically evaporated and I think we are in a fairly sort of febrile environment.

Obviously, the bond market is assuming that the Fed is going to have to cut rates fairly aggressively in the not too distant future and there is all this talk about inverting yield curves and so forth, which quite often basically is not a good sign in terms of foreshadowing recessions but then obviously Powell makes a speech in which he indicates that, if things cut up really rough on the trade front and there are threats to growth, the Fed is going to respond to that, which basically I have no doubt that they will do that.

So despite the fact that – and recent obviously macro-economic evidence in the States, the US economy still growing and so forth but it is decelerating and obviously the ADP employment numbers that came out today dramatically the lowest since 2010, effectively that represents basically a shelving away of growth because Trump’s fiscal stimulus, the impact of that is abating rapidly now and other world economies are basically fairly anaemic and US growth is clearly decelerating. The debate is really is this just a soft patch or is it something more serious than that?

So there’s quite a lot of things for the market to be concerned about but the market had become very short and so vulnerable to a squeeze and, lo and behold, the sort of Powell statements and so forth provided some sort of solace on the liquidity front, which caused traders to (if you like) take profits from their sort of short positions. So I think it is highly technical at the moment.

Lindsay Williams: Yes, indeed, it did smack of short covering as I said in my introduction but you have had two really good calls – well, actually, one really, really good call and that was you felt that it would be a melt-up when everyone was calling the end of the market all throughout 2018, starting with the February wobble and then continuing with the December disaster, 9% down on the S&P. You have always said there would be a melt-up. There has been a sort of a melt-up I suppose.

That is your first good call but the other call you have been making is for recession and suddenly, with the ADP private sector employment data from the United States, which was really quite a shock, and coupled with ISM number from the United States still above 50, it does sort of point to something happening. With the Fed having done a magnificent U-turn from December when they were going to be raising rates or rather the market participants thought they would be raising rates by 2, maybe 3, times 25 bps each during 2019, suddenly there’s going to be one or two cuts. It sort of engenders the feeling with me of: (1) confusion but then I am often confused; but (2) volatility, volatility at best.

Philip Saunders: Yes. I think that literally we are in this sort of volatile, probably at least sort of sideways, markets where you have panic attacks and rallies and so forth but I don’t think a recession is baked in the cake but the sort of balance of risks has clearly shifted in that direction and, if the trade talks really have broken down and you are going to see the hawks on both sides, both in China and also in the States, being sort of let off the leash, then that again is going to impact business decisions, business management decisions and so forth at a time when global growth or the global trade numbers have been weak.

So we are in this vulnerable environment whereby basically if a few accidents happen along the way, then that basically could sort of change things but at the moment basically we have got the equity markets pricing one thing, which is okay, it’s a bit sideways but this is another soft patch that we will get through with a little help from our friends at the Fed, and then the bond market which is saying basically we need interest rate reductions and we need interest rate reductions of a material amount from the Fed and we need them sort of maybe not at the next meeting but the one after that onwards. So we have got this dichotomy in markets which is going to be resolved one way or the other.

Lindsay Williams: A couple of indications that really have stood out for me in the last few days has been the weakness of the US dollar and the resultant performance of the price of gold in US dollars. I mean the gold price is now currently $1,341. Two weeks ago it was $50 below that and I know, having spoken to you and your colleagues over the last year or so, you have always mentioned the gold price and you have always mentioned having a little bit of your money in gold and I just wonder if that is coming to fruition now; in other words, the performance that you were expecting has come to fruition and if you are still keen on it.

Philip Saunders: So we have literally added further to our gold exposure and, as you know, we have been flagging it for a while now. We think it behaved really pretty well relative to a stronger dollar in the first part of this year, so it consolidated its sort of rebound from its rather beaten-up levels of last year and this is logical on two fronts.

It is logical because the interest rate differential negatives, with the Fed basically clearly having wanted to put interest rates up to probably somewhere closer to 3% while they were basically reducing their balance sheet, that the change of policy that was indicated earlier on in the year obviously foreshadowed the fact that basically interest rate differentials were not going to get much worse. Obviously, gold yields nothing and so therefore high interest rates are the sort of big enemy of gold.

We also felt that we were in a sort of volatile transitional period in markets, where there was a lot of uncertainty about growth and there was a lot of uncertainty about the relationship between China and the US and obviously that is the most important sort of macro-economic relationship. So in a volatile environment like that where interest rate differentials were reducing or real interest rates were coming down, that was fairly conducive for gold and it also suggested that dollar strength was likely to ebb and I think that basically the dollar has been weak very recently, having been pretty firm before that, but again, as that interest rate differential support reduces, then the dollar dominance potentially gets undermined.

So yeah, we think that – and the other thing, of course, is that basically obviously the long end of the treasury market has rallied like crazy and we think that that move is probably pretty much done and so we are looking for other defensive exposure to sort of move exposure that we have had. We felt that being long duration was a better trade than being long gold until very recently. Now we think that it is right to be taking profits, to be reducing longer maturity bond exposure, probably increasing short end bond exposure interestingly but again basically moving some of that exposure into gold.

Lindsay Williams: I gave you credit for your melt-up call. I didn’t give you credit for your gold call. I forgot about that. Your recession call, as you said, it is not yet backed in the cake, the US economy cake that is, that there will be a recession but, given the evidence of the last few weeks and given the complete flip-flop turn-around from the US Federal Reserve, it probably is going to happen. How are you positioning yourself apart from the gold exposure that you have already referenced to?

Philip Saunders: Well, we think that certainly a period of below-trend growth of the US is probably baked in the cake. How markets react to that are going to depend on obviously the Fed policy because it is not just a question of weakness; it is how weak.

Lindsay Williams: Yes.

Philip Saunders: Obviously, a period of below-trend growth is much more benign from an equity perspective, particularly in an environment of reducing interest rates and improving liquidity and potentially improving international growth, than a self-feeding recession, you know the US economy hitting some kind of [stall] speed and, once a recession starts to unfold, you get a number of things reinforcing themselves and that results in an earnings recession and obviously that is not really brilliant if you have got long equity positions.

So we have added to equity exposure to take advantage of the excessive weakness in December. We then obviously had the evidence of Chinese economic stabilisation on the one hand, the Fed shifting policy on the other, which meant that we were sort of comfortable being long but, as soon as we were aware that: (a) looking at how bonds were performing; and (b) looking at the sort of rhetoric or the trade narrative returning back to the trade wars rather than trade truces or agreements, that was a trigger to actually take profits and increase defensive exposure and we are in that kind of environment.

So I think that it’s a volatile sideways market for equities for now until we get a bit more clarity about whether or not, for example, the kind of data that we have had out today is real and we have hit a tipping point and basically we are going into a sort of sharper growth deceleration, possibly recession.

Lindsay Williams: Philip, thank you very much for your insight. Philip Saunders is the Head of Multi-Asset Growth at Investec Asset Management in London.

Philip Saunders
Philip Saunders Co-Head of Multi-Asset Growth

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