Published by Gbaf News
Posted on January 8, 2018
David Jane, Manager Of Miton’s Multi-asset Fund Range, Comments:
“We have been generally constructive on investment markets since the middle of 2016, a viewpoint that has proven successful. But as part of our process, we also like to consider the alternative points of view.
“We like to make investments where the evidence (data) and the narrative disagree and so we will attempt to test some of those alternative points of view to see whether they are based on data or simply assertions (narrative).
“One view that has been prevalent for several years now, that we don’t hold, is that economic activity worldwide will be held back by the high levels of debt in the system, or that this debt will lead to a contraction in the near future. Clearly, as we consider the economic environment, the data continue to point strongly to an expansionary environment. The leading indicators from most regions remain strong and point to a continued expansion for some time yet. Our view is that while the debt exists in theory, it has been neutralised, and a very significant portion of it is held by the central banks of the issuing nations.
“We think it’s safe to assume that the asset and liability these central bank holdings represent can safely be netted off in this case, as no central bank will be causing its own government to default. So, the debt overhang is a chimera and was solved many years ago with the start of the QE programmes. Will this change, as the central banks wind down their QE programmes and ultimately stop refinancing maturing bonds or sell existing holdings? Potentially, but ultimately it isn’t happening now and certainly, no central bank will want to endanger economic expansion simply to reduce the size of its balance sheet.
“Another view is that equity markets are expensive. This is based on various measures that compare current or near future levels of profits to market values, to create a price to earnings measure. The problem with this approach is that it has little or no predictive value; Markets were more expensive twelve months ago despite having had a stellar year. As we don’t believe we have much, if any, insight into future profits, saying that markets will go down because they are valued highly is a risky strategy that hasn’t proven successful. At the moment, we do have a greater level of visibility of future profits, as we know that the US has just reduced corporate tax rates by a material degree. As a result of this measure, after-tax profits for domestic US companies will be higher.
“A view we do hold is that it will be quite difficult to make money out of bond markets this year. An alternative view is that we remain in a deflationary environment and therefore yields will continue to fall. In fact, the falls in bond yields over the past few years have been due to falls in real yields, not inflation, perhaps because of central bank intervention leading to a scarcity of government bonds. Do we believe that real yields can fall back into negative territory sustainably into the future, leading to strong gains for bond investors? Perhaps the former is possible if the economy starts to contract significantly. But given the already low level of yields, significant gains in capital value are not on the cards.
“For corporate bond investors the outlook is arguably worse-if the economy contracts and real yields fall then credit spreads will expand and credit losses will grow, likely more than offsetting any yield contraction. In the alternative expansionary scenario, which we see as more likely, credit spreads are likely to narrow even further but this is very likely to be offset by rising yields leading to capital losses partially offsetting the income earned. The reality of the deflationary/disinflationary viewpoint and reality now struggle to co-exist as inflation has been rising for some years against the background of a growing economy. While this has been positive for credit markets, it is unlikely to lead positive returns in the future.
“In summary, we can see a number of alternative viewpoints, but they all seem to be based on assertions about a future which may exist without being supported by any evidence in current data, or may exist but doesn’t lead to any material gains for investors, should the evidence in the data change in the future, we will be willing to change our portfolios”.
David Jane, Manager Of Miton’s Multi-asset Fund Range, Comments:
“We have been generally constructive on investment markets since the middle of 2016, a viewpoint that has proven successful. But as part of our process, we also like to consider the alternative points of view.
“We like to make investments where the evidence (data) and the narrative disagree and so we will attempt to test some of those alternative points of view to see whether they are based on data or simply assertions (narrative).
“One view that has been prevalent for several years now, that we don’t hold, is that economic activity worldwide will be held back by the high levels of debt in the system, or that this debt will lead to a contraction in the near future. Clearly, as we consider the economic environment, the data continue to point strongly to an expansionary environment. The leading indicators from most regions remain strong and point to a continued expansion for some time yet. Our view is that while the debt exists in theory, it has been neutralised, and a very significant portion of it is held by the central banks of the issuing nations.
“We think it’s safe to assume that the asset and liability these central bank holdings represent can safely be netted off in this case, as no central bank will be causing its own government to default. So, the debt overhang is a chimera and was solved many years ago with the start of the QE programmes. Will this change, as the central banks wind down their QE programmes and ultimately stop refinancing maturing bonds or sell existing holdings? Potentially, but ultimately it isn’t happening now and certainly, no central bank will want to endanger economic expansion simply to reduce the size of its balance sheet.
“Another view is that equity markets are expensive. This is based on various measures that compare current or near future levels of profits to market values, to create a price to earnings measure. The problem with this approach is that it has little or no predictive value; Markets were more expensive twelve months ago despite having had a stellar year. As we don’t believe we have much, if any, insight into future profits, saying that markets will go down because they are valued highly is a risky strategy that hasn’t proven successful. At the moment, we do have a greater level of visibility of future profits, as we know that the US has just reduced corporate tax rates by a material degree. As a result of this measure, after-tax profits for domestic US companies will be higher.
“A view we do hold is that it will be quite difficult to make money out of bond markets this year. An alternative view is that we remain in a deflationary environment and therefore yields will continue to fall. In fact, the falls in bond yields over the past few years have been due to falls in real yields, not inflation, perhaps because of central bank intervention leading to a scarcity of government bonds. Do we believe that real yields can fall back into negative territory sustainably into the future, leading to strong gains for bond investors? Perhaps the former is possible if the economy starts to contract significantly. But given the already low level of yields, significant gains in capital value are not on the cards.
“For corporate bond investors the outlook is arguably worse-if the economy contracts and real yields fall then credit spreads will expand and credit losses will grow, likely more than offsetting any yield contraction. In the alternative expansionary scenario, which we see as more likely, credit spreads are likely to narrow even further but this is very likely to be offset by rising yields leading to capital losses partially offsetting the income earned. The reality of the deflationary/disinflationary viewpoint and reality now struggle to co-exist as inflation has been rising for some years against the background of a growing economy. While this has been positive for credit markets, it is unlikely to lead positive returns in the future.
“In summary, we can see a number of alternative viewpoints, but they all seem to be based on assertions about a future which may exist without being supported by any evidence in current data, or may exist but doesn’t lead to any material gains for investors, should the evidence in the data change in the future, we will be willing to change our portfolios”.
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