Iain Cunningham and Philip Saunders discuss risks and opportunities amid difficult market conditions.
Iain: So, Philip, it is not raining this morning. What are you doing with an umbrella and what does that say about 2019?
Philip: I think investors are going to need one of these in 2019. We are already seeing tailwinds turning to headwinds and it is going to be right to make sure you have got sufficient protection in your portfolios.
Iain: So challenging market environments as we are expecting over the next 6 months typically tend to throw up lots of opportunities and an ability to allocate capital into more medium term positions. Which areas of the market do you think are going to be the most attractive or compelling to do that?
Philip: Well, I think that we have been looking, as you know, very closely at Asian equities and particularly Chinese equities and we think really quite strongly that the next growth cycle is probably going to be Asian-centred. I mean that is where the sort of middle class emergences are strongest and these markets have been derating really for quite a long time.
The Chinese equity market peaked in 2015. It has been in a bear market. It is down over 50% since that peak. Multiples are pretty low and, although the momentum is negative in the near-term simply because of growth concerns and because of concerns about trade wars, this potentially is creating a fantastic longer term entry point.
So I think it is very important – even if the general environment is volatile, it is very important to be thinking about how you can take advantage of that environment to position the portfolio to take advantage of longer term opportunities.
Will there be a hard Brexit?
Philip: So, Iain, are you concerned about the possibility of a hard Brexit?
Iain: So it’s a good question and, obviously, there are lots of risks around it over the next 6-12 months. I think where we stand is a lot of the risk is in the price so markets have already heavily discounted it. We see a lot of UK assets trading at very cheap valuations and over the past 6 months we have actually begun to take a look at some of those assets and have begun to make some very small investments in a number of domestically-focussed UK companies.
Now, as we head forward, acknowledging that a decent amount of that is in the price, our view is ultimately that we are more likely to see a somewhat constructive path and, should that path begin to emerge, then those small positions that we have taken already in UK assets we would look to add to should that constructive path emerge.
I think more broadly for the portfolio, given that it is a global investment portfolio, the allocation to UK assets and to the pound are generally relatively small, so the overall impact of a hard or constructive Brexit would be relatively small on the portfolio.
The last cycle was America’s cycle whose will be the next cycle?
Iain: So one of the major headwinds that has faced the Asian region across this cycle has been the strength of the US dollar. So how do you think that is going to play out through the next cycle that we are talking about here?
Philip: Yes. I mean the cycle we are sort of coming to the end of has been very dominated by the US. The dollar has been strong. US equities have trounced most other equity markets. Actually, the treasury market has generated some pretty fantastic returns and we think that that has left the dollar at expensive levels. We think the US economy does have vulnerabilities. We think investors are sort of overly long US assets and currencies and markets have long term bull and bear market cycles on an absolute and on a relative basis.
So the last cycle was America’s cycle and this has resulted in a very significant valuation divergence between US assets and Asian assets and the growth picture for Asia, looking forward over the next 5-10 years, is manifestly more constructive than is the case for the US, which, although they are enjoying a sort of sugar rush of fiscal stimulus at the moment which has boosted growth to pretty high levels, the underlying rate of growth, even with the Trump effect, is still actually really quite modest by past comparison. Asia, on the other hand, has a growth dynamic which will act as a tailwind.