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Investment views

Podcast: A trade war is not the only risk

3 July 2018

 

Transcription

Lindsay Williams: As always on a Tuesday, we speak to Investec Asset Management. It’s the Big Picture sponsored by Investec Management in Cape Town and we are speaking to the Head of Global Multi-Asset Income in London and that is John Stopford.

John, the trade wars just keep on popping up on my screen every morning. I know that the Tokyo market was at a multi-month low this morning. I think Asian shares as a whole are at a 9-month low. The Americans seem to be shrugging it off but, as I said, Asia not doing so.

John Stopford: Yes. Clearly, there has been a sort of steady escalation of pressure. I think the assumption that we would make is that this is still an element of Trump’s negotiating style but clearly, as tariffs get implemented and as you get sort of counter-tariffs, the risk to growth builds.

So it is definitely a concern. I think it lowers growth expectations. It potentially will impact the profits of some businesses. So I don’t think it can be completely brushed off. By itself at the moment, it is unlikely to be something that causes a recession but, in combination with other things, that is also a risk down the line.

Lindsay Williams: Yes and, indeed, there has been another unintended consequence I think or maybe it was intended. That was the sharp fall in the Chinese currency over the last three weeks. It has rebounded this morning or today rather after two Chinese central bank officials vowed to keep it stable. Do you think that was managed by the Chinese because they can’t match Mr Trump tit-for-tat, dollar-for-dollar in trade wars?.

John Stopford: Well, I think there are a few things going on. I think China’s economy is slowing anyway so they had tightened policy some time ago. They have been running a more neutral policy but I think Chinese growth appears to have lost some momentum and so they are moving to an easier policy stance at a time when the US remains the sort of major beacon of growth globally, largely due to the sort of fiscal policy boost. The US is still growing very well. Policy in the US is still being tightened and so on. There were concerns about dollar liquidity. The dollar is relatively strong.

I think you should probably view the renminbi in that context but, yes, I mean trade is another consideration and the Chinese, to some extent, can manipulate the speed at which their currency moves and potentially the direction to an extent. I am sure there is an element of that but I think there is more going on than just trade wars.

Lindsay Williams: The move comes as the White House is set to impose tariffs on $34 billion worth of Chinese goods on Friday, Beijing vowing to retaliate in kind and there is also the China Mobile story. They are blocking China Mobile from entering the telecommunications market on national security grounds – Mr Trump that is, the United States of America. Is there a danger that trade wars become a different type of war?

John Stopford: That’s a very big question. I think, yes, ultimately I guess that is a risk, particularly if it leads to a worsening economic environment and that creates additional tension. There is clearly some battle for supremacy going on over the medium term between a sort of fading US world dominance and then the rise of China and so on. So I don’t think you can rule that out but I don’t think it’s an imminent risk. I think the bigger risk is that this thing continues to escalate and ultimately is bad news for the global economy and bad news for share prices.

Having said that, I think we are getting to a point where we have been in a sort of choppy, negative market now for about five months, so markets have sort of derated. I think quite a lot of bad news is in the price. It might go a bit further but actually, tactically, I think we are probably getting closer to a buying opportunity but it is about how you participate in that I think.

Lindsay Williams: Yes, indeed. We have been focussing, or rather I have been focussing, on China but there’s also India, there is also the Eurozone and I notice that the Dutch Prime Minister sat in the White House and interrupted Mr Trump. When Mr Trump said look, these tariffs are going to be positive, he said no, they’re not. I think that Europe is also starting to get a little bit fed up with Mr Trump and that could become quite nasty as well.

John Stopford: Yeah. I mean Trump’s obviously playing to [his space]. He is trying to protect – well, he thinks he is trying to protect the jobs, or at least the votes, of American workers. I think the US probably has been a little bit laissez-faire about trade but it has had benefits in terms of capital inflows from the rest of the world. It is now changing its tune and, hopefully, this will be a catalyst for some redrawing of trade contracts and trade agreements rather than the wholesale breakdown of global trade, which has been a huge boost to the global economy. As I said, we think it is at the moment a moderate drag on growth and on profits of individual companies rather than perhaps a catalyst for a significant fall in growth but it definitely needs to be watched.

Lindsay Williams: Indeed. You say in the brief piece that you sent me last week: “ Within Global Multi-Asset Income, we are rather defensively positioned at the moment, not primarily because of trade wars but rather more due to the stage of the cycle and US monetary policy though the trade wars do influence this slightly.” So it’s more rising interest rates in the States than it is of a little bit of a spat between certain countries?

John Stopford: Yeah. We are late in the business cycle. We are late in the bull market. I think it is the wrong time to take particularly heroic positions. I think it is better to be moving towards a more defensive stance although, as I said, I think, tactically, there may be buying opportunities.

So we are tending to play upside in equities through call options, which we think is still massively mispriced. So the market is still not charging very much to buy insurance against a continuing rally in equities even though that is typically what happens in the latter stages of a bull market and, despite the fact that the market can point to tens of different spheres, it is not really pricing much of a sort of higher risk of big equity movement. So optionality to us looks incredibly cheap. It looks like a good way of not participating in the downside but participating in the upside if there is any.

Lindsay Williams:Yes, indeed. As you say, we like being selective about what we own, using cheap options to capture upside and to tactically manage risk but still with a moderately positive view on growth-linked markets. If you look back historically, since you have been Head of Global Multi-Asset Income at Investec Asset Management, is this the most defensive you have been?

John Stopford: Yes. So I mean we weren’t running Global Multi-Asset Income during 2008. I would hope we would have been more defensive then but certainly we are in the process I think of positioning the portfolio for probably a bear market and probably a global recession at some point in the next 1-3 years. It is probably too early to get outright cautious now. There is still decent global growth momentum; earnings are doing okay; policies beginning to be tightened, but it is early stages.

There is quite a lot of bad news I think. People entered the year in a euphoric frame of mind. Now they are much more cautious, positioning is more cautious and that actually is a good thing. I think if you are looking for upside in markets, you don’t want everybody to be long and wrong, which they were in January.

Linsay Williams: Yes, indeed. As you say, we like being selective about what we own, using cheap options to capture upside and to tactically manage risk but still with a moderately positive view on growth-linked markets. If you look back historically, since you have been Head of Global Multi-Asset Income at Investec Asset Management, is this the most defensive you have been?

John Stopford: Yes. So I mean we weren’t running Global Multi-Asset Income during 2008. I would hope we would have been more defensive then but certainly we are in the process I think of positioning the portfolio for probably a bear market and probably a global recession at some point in the next 1-3 years. It is probably too early to get outright cautious now. There is still decent global growth momentum; earnings are doing okay; policies beginning to be tightened, but it is early stages.

There is quite a lot of bad news I think. People entered the year in a euphoric frame of mind. Now they are much more cautious, positioning is more cautious and that actually is a good thing. I think if you are looking for upside in markets, you don’t want everybody to be long and wrong, which they were in January.

Lindsay Williams: We are still quite close to the highs in the United States of America, whichever measure you want to look at – Nasdaq, S&P, Dow Jones Industrial Average – but just when will the markets start to discount what you have just described, in other words a potential recession in the next couple of years?

John Stopford: Okay, just on the first point, yes, US markets have broadly gone sideways but earnings have gone up very significantly. So forward PEs have come down pretty noticeably and, generally, across the world you have seen a correction in valuations, particularly in emerging markets, which have clearly taken the brunt of the sort of perception that dollar liquidity and financial conditions are becoming tighter.

In terms of when, I mean, historically, typically equities only finally peak about six months before a recession. So if we still think a recession is 12-24 months away, it is too early to panic and actually the final year or six months of a bull market is often one of the most rewarding, particularly now after a protracted period of sort of correction and consolidation in markets. I think it is wrong at this stage to get overly bearish. I think you need to think about the risks and, if you can find a way of skewing the odds in your favour, which we think options do, then that makes perfect sense in this sort of more uncertain latter stage of the bull market.

Lindsay Williams: So there can be a spike to new highs is what you are saying because of the stage of the cycle that we are at and, as you said, those last few months can be very rewarding indeed.

John Stopford: Yes, that would be our – that is certainly the historical precedent.

Lindsay Williams: John Stopford, thank you very much for your time this evening. That is John Stopford, who is the Head of Global Multi-Asset Income at Investec Asset Management in London.

 


Important information

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is not an invitation to make an investment and should not be construed as advice. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Investec Asset Management. The value of investments can fall as well as rise and losses may be made. In South Africa, Investec Asset Management is an authorised financial services provider.

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