Three of Jupiter’s most experienced fund managers, Ariel Bezalel, Talib Sheikh and Mark Nash, came together recently to discuss financial markets, interest rates, fiscal and monetary policy and where they see opportunities. Ariel Bezalel is Head of Strategy, Fixed Income, Talib Sheikh is Head of Strategy, Multi-Asset and Mark Nash is Head of Fixed Income Alternatives. The discussion was moderated by Magnus Spence, Head of Investment Trusts and Alternatives.
Is the pickup in Treasury yields a sign of higher inflation or a blip in a lower-rates-for-longer environment?
Ariel: It has been a fascinating start to the year. There has been a deafening amount of discussion on the reflation trade and excitement about reopening of the global economy and government fiscal plans. The next 2-3 years will see a robust growth backdrop but are the inflation pressures that we are likely to see over the next few months cyclical or structural? Are we going to see a sustainable pickup in inflation long term? My view is no. The structural issues that have impeded economic activity in last decade and kept economic growth at a lower level in a historic context are still prevalent. The first of those is the enormous debt problem, and there has been a 40% rise in global ex-financial debt in the last 12 months. Aging populations in developed markets and China and technology innovation also will hold back growth.
Talib: There has been a generational shift in how policy is made, the biggest change since the US came off the gold standard or when Paul Volcker joined the Federal Reserve (Fed). Central bankers now say they are going to be reactive to inflation rather than proactive. That is a big change. You have seen unprecedented stimulus — more money printed in the last year than ever before. Policymakers on both the fiscal and monetary side are trying to `kitchen sink’ this, trying to generate inflation, trying to create a world that’s seen as fairer. We do not know if they will be successful, but the key for investors is they are going to keep on trying.
Mark: This new policy experiment we are seeing, a kind of `MMT (Modern Monetary Theory) light’ — mass easing of financial conditions and almost unlimited fiscal support — this can build some traction in the global economy. But the market is getting too obsessed with the US inflation outlook. The market was hugely dovish at the end of last year and turned hugely hawkish three months later. The good news is that the Fed can take control of the yield curve again and can be dovish by not actually doing too much, and the market will not be so dominated by higher US yields, and this should open up other reflation trades.
Talib, how strong will the US recovery be, will it lead to inflation and could inflation be a solution to the debt problem?
Talib: The pace of the rebound in growth we are going to see this year will be, if not the strongest ever, at least in line with the immediate post-World War Two recovery. We had the world’s worst recession so it makes sense that you would have a huge bounce back. There are massive amounts of pent-up demand and around 10% of GDP in excess savings. People are going to go out and spend it.
Inflation is a political choice. There is the confluence of change in central bank policy plus governments wanting to be more redistributive. In the US, the debt is mostly held by China and other foreign investors. The burden of higher inflation will be borne by them, which ultimately makes inflation the more palatable choice for US policy makers. Whether they can succeed in generating inflation remains an open question, but it is the only solution to all the debt that Ariel has talked about. You get rid of it through inflation or default — but default is not palatable.
Ariel, how do you view the strength of the dollar?
Ariel: It is one of the biggest surprises coming into this year. If we start to see Treasury yields gap even higher to 2%, that is going to further strengthen the dollar and will be another problem for global activity. The market may start to look to the Fed. We had that violent selloff in Treasuries this year, and the Fed was ok with that. If yields were to sell off violently again you could start see the Fed debate the idea of yield curve control, or putting a cap on yields, to protect the recovery. You have already seen some cracks in the EM (emerging markets) complex. We had a substantial devaluation of the Turkish lira, then the Russian rouble and the Indian rupee is under significant pressure.
It is worth noting that the yield curve was aggressively steepening in first two to three months of the year and now is starting to flatten out, which is telling you the market thinks that we probably have seen the worst of it and things maybe had gone too far.
Mark, what about inflation in the rest of the world (ROW)?
Mark: You do need a synchronised lift to the global economy if you are going to get successful reflation. In 2018 the US had the ingredients to do OK, but ROW slowed quite aggressively. One of biggest risks at moment and it has been a surprise, is China. China is the only place in the world that is not prioritising inflation. China is focusing on financial risks again and is deleveraging its economy quite aggressively. Whereas western economies are going for it in terms of fiscal support and easy conditions, China is going in the other direction. There is a risk that as it de-levers state-owned enterprises the consumer does not step up, which is needed for successful deleveraging. There is also a risk of defaults. China’s real rates are quite high, and debts are quite high. China credit has been widening for the last few months reasonably aggressively.
There is quite a lot of uncertainty, at least in the short term; where do you see opportunities?
Ariel: Coming into the year the strategy had on one side an allocation to high-quality AAA-rated sovereigns. We exited some short-dated Treasuries that did really well for us last year and have been buying Chinese government bonds at much higher yields. On the other side, we are of the view that credit markets are expensive, and spreads are back to the tights. The global economy for now looks to be in decent shape so we raised our allocation to high yield and reduced investment grade. Within high yield we focused on some short duration plays offering decent yields along with some total return, special situation trades.
Talib: The question is how much of the recovery is priced in? The strategy is neutral high yield and long financials credit. We do not hold investment grade credit. The bulk of our risk taking is higher quality, developed market equities. We are overweight Europe and overweight the UK for the first time I can remember. Those more cyclical markets can have a moment in sun. The dividend environment looks attractive. When we look through to summer the million-dollar question is when do we go long duration?
Mark: The strategy has taken the side that we are in the early stage of the reflation. You know that credit spreads are going to tighten, you are going to get a falling dollar environment, EM might do quite well. and then you are going to get curve steepening and finally dollar selloff. We are at stage where we have seen the US bond selloff. That should start stabilising. You should start to get more dollar down, ROW reflation coming in.