Politically Correct Investment Strategies
Both written and unwritten constitutions are under threat with the pillars supporting them under attack, as populist forces gather, chipping or pulling apart conventions and traditions embedded across Western democracies. Looking back at periods of calm, today’s investors are being challenged in a way unimaginable a decade or so ago.
For those of a certain age, the 1980’s can be remembered as a period of reform and hope. Free market, liberal economics was in its infancy and was being organised to embrace populations with the allure of financial gain. In the UK, it was the right to buy scheme and share privatisations that engaged the masses. In the US, it was tax cuts designed to incentivise entrepreneurship and create the opportunity to participate in the American dream. The money making machines were being assembled in a way to excite people and on the political stage the Berlin Wall was being dismantled. All in all, it was an age of hope and for many in the Western world, opportunity. Western democracy was in its primacy.
Today, the world has become unrecognisable and both politics and economics are fragmenting to challenge the world order. Because of it, asset allocation decisions based on assumptions that economies will continue to follow a conventional path built around globalisation may soon need to be questioned.
Even without the prospect of a Trump-led reversal in globalisation, evidence was already emerging to challenge growth in global trade. In September 2016, the World Trade Organisation (WTO) cut its forecast for global trade growth, predicting this would rise in 2017 by 1.7%, down from the WTO’s previous estimate of 2.8% made in April 2016. This marked the first time in 15 years that international commerce was expected to lag the growth of the world economy. As the WTO said, “world trade growth has begun to dip”.
WTO Director-General Roberto Azevedo said in the six-monthly trade outlook report, “the figures should be a wake-up call for governments. We need to make sure that this does not translate into misguided policies that could make the situation much worse, not only from the perspective of trade, but also for job creation and economic growth and development which are so closely linked to an open trading system”.
Hidden beneath this statement is alarm that the global open trading system we have enjoyed for so long is under threat. The themes are set by Brexit, Trump and Putin, and they are fuelling popular discontent that led to the near failure of the Comprehensive Economic Trade Agreement (CETA) between Canada and the EU and perhaps now the trading arrangements the US has with the rest of the world.
The threat to world trade is not the only concern arising from the “misguided policies”, loosely referred to by the WTO director and now being amplified by talk of a massive fiscal expansion in the US. The ingrained philosophy behind monetarist policies is being replaced by the populist rhetoric of the benefits fiscal policy may bring. The reasons for it are as much political as economic, as Mark Carney and other central bankers are finding out to their cost.
Popular feeling is that monetarist policies have made people poorer. Politicians elected on policies designed for mass appeal, are likely to adopt populist policies. Fiscal policy may then be applied in a manner designed to appease an unhappy electorate, who have endured years of flat wages and sharply higher costs (in the UK) for housing, education and (rail) travel.
One of the many consequences of loose fiscal policy will be a sharp increase in money supply resulting in a classic supply shock as demand surpasses supply, pushing prices higher and as prices push higher, with them will follow wages.
At a global level it would seem we are at a major turning point, one likely to create significant and uncertain changes to the geopolitical environment we have grown used to over the past five decades. As a result, there will be changes for the way investors approach asset allocation, arising from the switch from monetarism to fiscal policy and from the potential reversal of globalisation.
Asset markets moved sharply (currencies, bonds and equities) after the US election result became apparent. But the initial, some would say, knee jerk reaction will set in train a shift in the assets investors will want to hold and those they want to sell. Set out below are some of the trends we anticipate developing over the course of the Trump presidency.
If Donald Trump follows through with his expansionary policies, a further $14tn will be unleashed on a US economy already close to capacity. The effects are already being seen in government bond markets, not just in the US but globally. Investors have suspected for some time that government debt levels are unsustainable and were supported only by policies that allowed governments to print money to buy their own debt.
Many asset managers have considered that inflation could change course as a result of prolonged monetarist policies and have slowly been accumulating a higher exposure to index- linked securities which will perform well in anticipation and in consequence of higher inflation.
Following the US election the move away from conventional government bonds is likely to accelerate and yields will rise (yields move inversely to prices), impacting on the cost of borrowing and also interest rates that have for so long been set at historically low levels.
Commodities tend to perform well in a more inflationary environment aided by governments ramping up spending on infrastructure (infrastructure spending is one of Donald Trump’s more discernible economic policies).
Investors are increasingly likely to want to hold commodities as a real asset to protect themselves against an inflationary environment. The asset class, for so long unloved by investors, may come back into vogue as other “safe” havens lose their appeal.
It is a poor reflection of many Western governments that the opportunity to borrow cheaply to fund much needed infrastructure spending is ebbing away. The political will to engage in this activity has, until now, been missing.
A new generation of leaders seem determined to address this and whilst the cost of funding this activity will surely rise, we can expect spending on everything to accelerate over the coming years, whether it is railways in the US, housing in the UK or internet connectivity in Germany.
The activity arising will have an impact across a range of sectors from commodities to construction.
Currencies have been part of a nil sum game, as in the absence of other economic stimulus, governments have pursued policies to devalue their currencies to boost trade. The switch from monetary to fiscal policies will change the relationship investors have with currencies as it will be they not central banks pushing currency values lower. Those governments seen as the most fiscally imprudent, are those likely to suffer most.
The upshot is that governments will have to pay more to borrow. The virtuous circle of debt issuance and purchase between the US and China is likely to cease, potentially leading to downward pressure on the US Dollar.
Emerging market economies, to varying degrees, may suffer from the (stated) withdrawal of the US from global trade and higher US interest rates. Emerging markets have a heavy reliance on US markets to purchase their manufactured goods and falling volumes of trade from the US would be detrimental to many emerging market economies, particularly those without commodity exports to prop them up.
Some of you will have concerns regarding the impact of Donald Trump’s election on our Ethical Sustainable Thematic (EST) portfolios. There are worries over the UN climate agreement however, in our opinion, the world will press on, irrespective of the US. Whilst some of Trump’s early announcements on existing climate change accords have not been positive, we think there may be some good news on the EST front – infrastructure – water and rail in the US need billions of dollars of expenditure – this will be good news for EST investors. Some of his pre-election rhetoric, as we have seen, is already being watered down. The US has made big strides in renewable energy, especially in the area of solar power and whilst Trump may be a climate change sceptic, he won’t want to damage US industry. It is vital that these alternative sources of power do remain viable in their own right.
Another point to consider is that Trump, will, no doubt, given his political views, want to expedite the US’s move away from any dependency on middle eastern oil and renewables have an important part to play in this.
Holden and Partners’ portfolios
Over the last 12 months and prior to the US election, the Investment Committee at Holden and Partners has considered the positioning of our client portfolios with some of the aforementioned themes in mind. In this new era of increased uncertainty what remains constant is the need for investors to maintain exposure to adequately diversified portfolios. Excessive over or underexposure to the wrong asset class in these unpredictable times can exacerbate the risk inherent in a portfolio.
This year, we have increased and added to weightings in infrastructure through exposure to renewables related projects and also through conventional infrastructure funding.
In recent months we have also increased our exposure to index-linked bonds, which should perform well, as loose money, via fiscal rather than monetary policy, pushes money into the hands of consumers. We are now content with the exposure we have to this sector which could also benefit from government expenditure on infrastructure projects. However, we are mindful that a higher interest rate environment could have a negative impact on the sector.
Portfolios have good exposure to commodities, via physical as well as stock market allocations. We see this adding to the inflation protection already held in portfolios.
As the world becomes more unsettled, it is more vital than ever, that clients, irrespective of whether they have a need for income, have adequate exposure to strong robust companies with resilient revenue streams. Our clients have investments in such companies through good weightings in UK and global income funds.
Property has not been mentioned in the notes above. The greater part of our exposure to commercial property is in the UK. Ironically, the negative overtones for this sector arising from Brexit may be mitigated by revived interest from the US, as some firms dependant on open global markets relocate to London. The fall in sterling has increased the attractiveness of this sector, with its strong upward income streams, to foreign investors.
Portfolios have a balanced exposure to the major currencies, namely Sterling, Euro and the US Dollar. Allocating assets purely on the basis of underlying currency exposure is often mistaken. The Investment Committee take the view that asset allocation decisions should be currency neutral. That said, recent changes to the political landscape will mean currencies take a step closer to centre stage, as far as asset allocation decisions are concerned.
Three or so years ago stirrings across the political landscape were seen as outliers and of little relevance to asset markets. Today, the manifestations of them are centre stage and cannot be ignored at either a geopolitical or economic level.
Investment decisions will in future need to embrace a broader range of issues and account for not only the words, but actions of politicians. Portfolios of the future will not only need to be economically correct, but politically correct too.