As we enter the final couple of months of what has been another positive year for risk assets, a selection of fund managers share what is ‘spooking’ them most this Halloween…
The haunting sound of rate hikes
Hartwig Kos, CIO and co-head of multi-asset at SYZ Asset Management
Neither the trapdoors of European politics, nor the Adams family in the White House, have disturbed the market’s spirit – while the wicked witch of Downing Street has also not made us jump yet. We have even learned to live with the great unknown called Brexit. As a result, our steadfastness in light of the Rocket Man’s nuclear horror stories and the market’s lack of shivers at the prospect of global protectionism should come as no surprise.
We have learned to ignore so many scary things and to regard them as immaterial, assuming that the only thing that counts are rising equity markets. However, there are still poltergeists that haunt our dreams: interest rates. What makes us quake is Mario’s Scissorhands cutting down our beloved QE, or Hocus Pocus Janet playing trick or treat with treasuries and mortgage-backed securities. What robs our sleep are whispers of ‘expensive’ from little ghosts called valuation, which tell us day in and day out that bonds are overvalued and equities are not cheap either. How long will this scary state last, with no Ghostbusters in sight?
Egregious excess in long-dated yields
Jacob Mitchell, CIO of Antipodes Partners and manager of the Antipodes Global Fund – Ucits
The market’s sponsorship in recent years of bond proxies, leveraged roll-ups, and other long duration asset exposures has reached extremes. Low volatility strategies have also been a major beneficiary of central bank purchase programmes, with such interventions possibly reinforcing the belief that ‘low vol’ should be equated with low risk.
We have previously written about a potential scenario associated with a global growth surprise leading to an accelerated normalisation of central bank policy settings. Macro data over recent months seems to confirm this prospect, as do equity market moves. However, long-dated yields – with a small number of exceptions – are yet to reflect what equity markets are now embracing. As in the forest fire analogy, we at Antipodes are more inclined to believe that extended periods of low volatility are likely to be associated with building risk, but with the timing of its manifestation inevitably difficult to predict. We therefore continue short the most egregious examples of this excess as part of our overall portfolio positioning.
Cybercrime is a universal spectre
Thomas Fitzgerald, associate fund manager at EdenTree Investment Management
The threat of cybercrime is universal and not limited to companies of a particular size or sector. PwC found in a UK survey of 664 executives and I.T. professionals in 2015 that an increasing number of both small and large companies are reporting security breaches, with 90% of large organisations (more than 250 employees) suffering a security breach in 2015. Earlier this year, security specialist Symantec reported 1.2 billion cyber breaches globally in 2016, leading to 1.1 billion individual identities being exposed – a 92% increase year-on-year. The same report records more than 460,000 ransomware attacks in the same year, a 36% increase year-on-year, with the average ransom amount $1,077, a 266% increase.
The number and scale of ransomware attacks we are witnessing clearly shows the vulnerabilities of the global digital economy. These attacks raise questions about whether or not countries that are developing and stockpiling cyber weapons can do more to protect those tools from being stolen and used to cause damage.
Avoid risky UK pharma companies
Jeremy Lang, co-founder and partner of Ardevora Asset Management
In the current environment, most companies are finding it harder to grow, making normal management behaviour risky. The phenomenon of faster growth companies slowing down is most obvious in healthcare, where there are a few global speciality pharma companies quoted on the UK market. The prime examples are Shire and Hikma, which both do a lot of business in North America.
Until recently, these companies have been able to grow easily through a combination of new drug launches and higher prices. But this growth is not so easy to achieve now. Growing by pushing prices up, in particular, has become much more difficult. We have seen some high profile businesses in North America run into trouble as the tougher environment has evolved, with management pushing on with old growth plans regardless. Major examples are Valeant and Endo. Usually when economic risk is rising, investors are tempted to buy healthcare because demand for drugs is usually left unscathed. They look safe. However, we do not think Hikma or Shire are safe now.
The dangers of duration
Jon Jonsson, manager of the Neuberger Berman Global Bond Absolute Return Fund
We have negative headline duration on our Neuberger Berman Global Bond Absolute Return Fund as we continue to see more opportunities in reflationary stories across developed markets. Historically-low sovereign bond yields faced by investors today cannot be sustained indefinitely amidst an improved economic outlook, rising inflation and a continuously improving labour market situation.
Inflation expectations have further to recover should fiscal agendas be followed through and the US yield curve continues to reflect a milder paced hiking cycle than indicated by the US Federal Reserve. We believe this extremely gradual pace for hikes priced by markets is a low bar to exceed, even if the path of hikes is as slow as we expect.
Electric vehicles need not spook oil markets
Richard Robinson, manager of the Ashburton Global Energy Fund
The one trend spooking the oil market this Halloween is the rise of electric vehicles (EVs). However, as with most apparitions, this threat dissipates once a light is shone upon it. Currently, the number of cars in the world stands at approximately 900m. The consensus view is that the number of electric or hybrid electric vehicles will rise from 1.2m to 200m by 2025 – a 165-fold increase. But what impact will this really have on internal combustion (IC) car sales and the oil market?
Driven largely by China and India, the number of IC cars is expected to rise by about 700m over the same period. With an almost doubling of the IC fleet over the next eight years, it is hard to argue that oil demand will fall. Further, Chinese SUV (sport utility vehicle) sales penetration over the past five years has increased from 5% to 40%. By 2025, 122m SUVs are expected to reach Chinese roads, ten times the projected number of EVs. SUVs are 20%-30% less fuel efficient than the average saloon car, suggesting oil demand is not going anywhere.
The unknowns in unwinding
Witold Bahrke, senior macro strategist at Nordea Asset Management
From a top-down perspective, what concerns us most is the ongoing regime shift in monetary policy. We are not only seeing conventional tightening – higher interest rates – but now also unconventional tightening – or quantitative tightening – as the Fed reduces its balance sheet. Why could this spook markets? Basically, because it has never happened before.
Although there are good reasons why the Fed is doing what it is doing in limiting financial imbalances, central banks are to some degree flying blind in the unwinding of the biggest experiment in recent monetary history – QE. Many analysts are trying to make investors believe it is all going to happen in a smooth way, which will be easily digestible for markets. Interestingly, the same analysts told us for years and years that QE and the resulting wall of liquidity insured investors against potential drawdowns. As QE is reversed, should we now all of a sudden not worry anymore?
Korean concerns underestimated
Nikolaj Schmidt, chief international economist at T. Rowe Price
The most likely endgame on the Korean Peninsula is that North Korea obtains full nuclear capacity and that the United States has no choice but to accept this. However, the process is unlikely to be smooth and we expect frictions to increase between the US and China.
An abrupt increase in tensions between the US and China presents a permutation of the geopolitical game that has consequences that are not priced by the financial markets.
Don’t let solid returns be spooked by a ‘Texas Hedge’
Fraser Lundie, co-head of credit at Hermes Investment Management
Credit, as an asset class, has benefitted strongly from the long-running bond bull market and, perhaps more importantly, from the negative relationship between government bonds and credit spreads. This served as an internal defence mechanism for corporate bonds, enabling a smoother return profile than what other asset classes could offer.
We recognise that this is unlikely to continue as inflation expectations rise and central banks inch towards monetary policy normalisation. As such, this defence could well become a ‘Texas hedge’ – a financial hedge that increases rather than reducing risk.
As we emerge from this central bank-induced bubble, rather than hoping the status quo continues, we will use our mandate to invest worldwide and throughout capital structures to access an expansive set of opportunities and sources of liquidity.