19 May 2016
China's futile fight, bond insanity and a housing bubble down under
FundCalibre director Clive Hale speaks with William Littlewood, manager of Elite Rated Artemis Strategic Assets
William Littlewood, manager of Elite Rated Artemis Strategic Assets, is a bear at heart. Not the brown grizzly type nor the soft cuddly teddy type, but someone who seems to be almost always negative on the outlook for markets.
I met him last month and had a very interesting chat. If you agree with his view that the investment world is going quietly mad, read on.
Unsustainable market intervention
Equity markets have been strong across the board. Janet Yellen, the Chairman of the US Federal Reserve (Fed), said that she would “proceed cautiously in adjusting policy”, weakening the US dollar and boosting markets. China cut its reserve requirement ratio (the amount relative to deposits that banks must keep with the central bank) for the fifth time in just over a year, and also pledged to boost growth.
This caused the price of iron ore to jump by 19% in one day, the largest move on record. Emerging market indices led the way with Brazil up 17% over the month and China gaining 12%. It also dragged up markets in the US (up 7%) and Japan (up 5%) and, to a lesser extent, the UK and Europe.
Whether this is really good for markets seems questionable in William's view. China’s continued fight against the business cycle seems somewhat futile. More intervention is not a sustainable solution. Similarly, Yellen’s 'doveishness' was set against the caution that low rates mean the Fed’s “ability to use conventional monetary policy to respond to economic disturbances is asymmetric”. In plain English, this is an acknowledgement that with rates stuck at near zero, if a recession turned up tomorrow, the Fed would be very short of options.
Having bought into the market in January and February, William and the team have recently been taking profits, reducing their net equity exposure in the fund from 55% to 43%.
Bond market insanity persists
Meanwhile, the insanity gripping bond markets has persisted. As William pointed out: Japan was able to issue a 30-year bond at a yield of just 0.47%, an all-time record low. If Japan’s finances seem troubled now, think of what the position might look like in 30 years’ time, when its overall population is expected to have declined by 30% and its working age population by 33%. The country will have more people retired than working.
April's key event was further action from the European Central Bank (ECB). It dropped its overnight deposit rate from -0.3% to -0.4%, increased quantitative easing from around $60bn to $80bn per month and pledged to start buying corporate bonds.
Following the ECB’s actions, over €16bn of European corporate bonds traded with a negative yield! This included the three-year bonds of Royal Dutch Shell, a company that clearly has no control over the price at which it sells its product (oil).
The sovereign debt markets, meanwhile, continue to produce striking examples of lunacy. Spain’s five-year bond yields fell to less than 0.4%, against an average yield of 3% in recent years and a peak of 7% during the 2011 eurozone crisis. This, for a country with 24% unemployment and no effective government. Elsewhere, former ‘PIIG’ (Portugal, Italy, Ireland and Greece) Ireland managed to sell some 100-year bonds at a yield of just 2%.
Increasing evidence of an Australian housing bubble
Following the sharp rebound in oil prices, the team took profits from their position in the Russian ruble. Trade data continues to be weak across the Asian region, with the most recent data showing exports for China and Korea down 25% and 20% year-on-year. So they used the recent strength of the currency to trim their position and reduce overall net exposure to Asian currencies from 16.2% to 15.7%, the lowest level since the fund’s inception.
They added to their 'short' positions in the Canadian and Australian dollars, two resource-based currencies. The Canadian dollar has appreciated by over 12% against the US dollar since its lows in January. Following the collapse in oil prices, Canada’s current account deficit has increased to over 3% of GDP. However, nearly 90% of Canada’s oil production is derived from oil sands, a long-life, high cost and polluting form of producing energy. Given increasing environmental concerns and rapid cost deflation across the oil supply curve, the long-term outlook for the oil sands industry looks very challenging.
They increased the short in the Australian dollar from 3.5% to 5.9%. This was in part as a tactical response to the bounce in base metals prices, but also due to increasing evidence of a housing bubble. Australian house prices seem barely to have noticed the bust in the prices of the base metals on which the country’s large mining sector depends.
The prospects for precious metals are positive
The price of gold is largely unchanged in recent weeks, while platinum has increased by 5%, lowering its discount to gold from 25% to 21%. The overall precious metal position in the fund is now at 17% as they continue to think that the prospects for precious metals are positive against a backdrop of negative interest rates and continued money-printing.
Will gold go higher in a volatile market?
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Clive's and Williams' views are their own and do not constitute financial advice.
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