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BREAKFAST BRIEFING: Investment Rulebook Torn Up After 2008 Crisis; What Is "New Normal?"

Tom Burroughes

29 May 2013

Investment rules of thumb about supposedly safe asset classes have been thrown into the air in the aftermath of the 2008 financial crisis, while emerging market assets are often seen as less risky than their more established counterparts, a conference in London heard recently.

But while some of the gloom stemming from the jarring events of five years ago has not fully dissipated – as demonstrated by continued worries about the eurozone’s fiscal problems – the picture is far from bleak, delegates, attending the Breakfast Briefing entitled The “New Normal” Vs The “Old Normal”, were told. The event was organised by ClearView Financial Media, publisher of this website, in association with the World Gold Council.

Among the key issues facing investors and their advisors, delegates heard, is exactly how, or when, central banks such as the US Federal Reserve decide to reduce the expansion of the money supply, otherwise known as quantitative easing, if economic signs suggest a sustained recovery is under way.

Willem Sels, head of investment strategy and chair of the investment committee of HSBC Private Bank (UK), said the outlook for the world economy is “just about strong enough” to be constructive for global equity markets. “We don’t want the economy to be too strong because monetary policy will be then less supportive,” he said.

As for bonds, clients want some “cash-plus” exposure, and are holding short-dated paper. “We like credit risk but don’t want duration risk,” Sels said, noting that many of the effects of QE are now priced into bond yields. On balance, he said, QE is now more supportive to equities than bonds.

Sels pointed out that one issue for clients at home in the UK is the seemingly incongruous mix of a strong stock market and a relatively sluggish economy. “The main question from clients is why the equity market is rallying when the UK economy is not doing very well,” he said.

In the US, however, the picture was less ambiguous, despite some continuing concerns, he said. “The US economy now has a lot of positive forces behind it,” he said, citing developments such as shale gas exploitation, and the drastic actions taken to recapitalise and support many banks, among others. The plight of the US economy is crucial as the value of the country’s stock market accounts for half of the total market capital of the world’s stock markets.

There have been some small improvements in the eurozone and some capital flight from the single currency bloc has slowed or even stopped, Sels said.

There are risks in the short term to emerging markets, Sels said, although “the longer term remains quite constructive. There are questions about how China is going to rebalance its model”.

“We believe that you need alternative assets to diversify your portfolio,” he said, referring to hedge funds, private equity and property, among others. “You don’t want to go too far up the risk spectrum to get yield,” he added.

New normal

Marcus Grubb, managing director, investment and global strategist at the World Gold Council, said the “new normal” environment was driven by factors such as the high central bank purchases of government debt. “We’ve seen major shifts in perceptions of where we are in this credit and economic cycle. This is not a normal turn in the economic cycle. The UK government owns almost 30 per cent of its own bond market. Japan is heading in the same direction and the US owns 25 per cent of its bond market,” he said.

“We’re not in an equilibrium here…we are in a stable disequilibrium here; the question is how long it will last.”

At the moment there is slightly less concern about portfolio risk, which is probably one reason why gold prices have eased in recent weeks, Grubb said. (He referred to the sharp recent price declines in the yellow metal.)

On one scenario, the equity market rally in some areas is justified, Grubb said. For equities, any rise in inflation pressures from current levels will hit investors. “In the near term, with gold we have gone from a 'risk-off' environment to a 'risk-on' one. Bonds haven’t really sold off. That is not the scenario that I thought would happen. There is likely to be a period where it is not going to be so favourable for gold,” he said.

Grubb said that investors should have up to 35 per cent of a portfolio in alternative asset classes.

Chris Wyllie, chief investment officer at Iveagh, the wealth management firm which manages the assets of the Guinness family, and others, warned that if some markets reverted to more “normal” levels than of late, some investors stood to suffer heavy losses.“Should bond yields return to 30-year averages, investors in long dated gilts would lose half their money or more.  Even a much milder scenario would still result in losses in the high teens – a frightening prospect for risk-averse investors," he said. 

“The real test might be yet to come, which is that risk-return assumptions get turned upside down. What happens if government bonds underperform other assets in a downturn?” he said.

“We take a seven-year time horizon and we’ve no idea of how long this 'new normal' period will last.”

A great deal of positive news is now in the US stock market, he said, arguing that in terms of forecast earnings, US shares are priced at 23 times earnings, which is above historic norms. Currently, prices imply that US firms achieve double the earnings per share of a European one, which does not make sense, he said.

On gilts: “We try to get it down as much as possible but we don’t get out of it entirely.”

The UBS view

Caroline Winckles, deputy head of the chief investment office research, UK, at UBS Wealth Management, said that a big issue is that assets once considered safe are not so viewed any longer. Areas once regarded as risky, such as emerging market corporate bonds, are now, arguably, less risky than, say, certain forms of corporate debt, she said.

She said a big issue is that assets once considered safe are not so viewed any longer. Areas once regarded as risky, such as emerging market corporate bonds, are now, arguably, less risky than, say, certain forms of government debt, she said.

“It is very important to have continuation of education for our clients because of the changing nature of the markets and risks.”

The biggest risk is the interplay between monetary policy and the economy, she continued. One risk is that, despite a lot of quantitative easing and other moves, the global economy fails to ignite and falls into a “liquidity trap”, she said.  

The other risk is that QE does have an impact and the economy starts to grow but then central banks implement the wrong policies to deal with it. “We are telling clients they should have a diversified approach in a risk-adjusted portfolio”

Clients are overweight equities and emerging market corporate debt, and short on the euro. There is a risk that the euro continues to lose ground against the dollar. Clients are also overweight US stocks.

On the UK, UBS recommends a neutral stance on equities. “Earnings growth doesn’t look that good. This year  consensus  forecasts  5 per cent earnings growth ".  "However the stock market has re-rated as the equity risk premium has gone from 12 per cent to 10 per cent,” she said.

Currency conundrums

Luciano Jannelli, chief economist at MIG Bank, said that efforts by policymakers in most countries to contain deflation have succeeded.

With emerging market growth rates slowing, many commodities will remain under pressure, and that includes gold to some extent, he said.

“Much of this will rotate around China…China will protect a gradual rise in the renminbi, benefiting the Singapore dollar and the Malaysian ringgit,” Jannelli said.

Jannelli expects the dollar to rise against the euro, sterling and the yen….”The yen is now in a chapter all of its own.” By some measures, the dollar is now higher in value than before the financial crisis. There are several reasons: the current account deficit of the US has shrunk, while US savings rates have sharply increased from historic lows. Also, the US has come out of recession earlier than the eurozone, so the outlook for interest rates means that there is more of a chance of rates rising in the US ahead of those elsewhere. This yield attraction benefits the dollar. The debt-to-GDP ratio in the US has also dropped.

The Fed is likely to end QE very slowly, preferring to let bonds mature rather than to trigger debt issuance.

As emerging market countries develop and become more consumer-focused and “middle class”, Jannelli said, and as current account surpluses shrink, there will be less spare cash to buy gold.