Multi-Asset with Alastair Baker, Schroders

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  • 07 mins 30 secs
Alastair Baker, Multi-Asset Fund Manager, Schroders, discusses his views on synchronized global growth, markets taking bad news in their stride, the likelihood of a US/ China trade war and his summary of current market risks.


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PRESENTER: For an update on world markets, I’m joined now by Alastair Baker. He is a fund manager in the Multi-Asset team at Schroders. Well, Alastair, everyone’s talking about synchronised global growth this year, do you believe that story? Are you concerned at all about when the next recession is going to kick in?

ALASTAIR BAKER: So I think clearly for the first time in a long time we’ve had a synchronised uptake in global growth. You’ve had Europe doing well, the US doing well and also emerging markets participating. So that supported strong asset performance over the course of 2017. I think, you know, why people are thinking about recession is because clearly the US has been growing now for nine years. If it continues to the end of June 2018, which is likely, it’ll be the second longest expansion on record since 1854, and it’s almost going to be the longest. 1991 to 2001 was 10 years. So we could be in for one of the longest expansions on record.

But in that context also we’re at a situation where unemployment in the US is now at 4.1%. Prior to the last recession in 2007 it got down to 4.4%, so we’re almost at full capacity. So the question has to be how long can this continue? So what we are now being more is much more vigilant about our cyclical indicators. Because valuations are clearly towards the upper end of their ranges, and we need that continuation in cyclical momentum to justify continued asset performance. And that’s really what we focus on multi-asset is valuations and where we are in the cycle.

PRESENTER: So what are some of those indicators that if they turn that will be red warning lights on the dashboard for you?

ALASTAIR BAKER: So I think at the moment what we’re looking at is broad cyclical momentum. That continues to look good, but we’ve got now very high levels and we’re kind of stabilising. And if that begins to roll over a bit, then we need to get more concern. Because it’s not so much the recession stage, it’s actually that slowdown phase where we transition from high growth to lower growth where the markets get nervous, because they try and forecast forward into that recessionary phase.

The second thing we’re monitoring is liquidity conditions. Clearly the Federal Reserve is tightening rates, and that’s withdrawing liquidity from the global market. And the question is will that pace pick up? And what our analysis shows is equity valuations, although high on an absolute basis, still look fairly attractive relative to bonds, it’s only as we begin to approach 3.25% on the US 10-year that things become undermined in terms of valuation. So that tightening liquidity. If rates were to continue to back up as quickly as they have over the last quarter that would be a cause for concern.

The second release valve we really have in the global economy at the moment is the weakening of the US dollar, we saw that over the course of 2017, and what that weakening allows is things like emerging markets to continue to recover and really participate in global growth. So that keeps the global economy firing on all cylinders. So a more rapid tightening of liquidity, a strengthening of the US dollar, a meaningful strengthening of the US dollar, would be two things of concern, which we think would help to push us into a slower growth environment, or a simple natural rollover of the indicators because we’ve just run out of capacity.

PRESENTER: Now I suppose one thing that a lot of people have been pointing out on markets in recent years is they’re taking any piece of bad news in their stride, it doesn’t seem to create much of a wobble. Why is that happening?

ALASTAIR BAKER: So I think we need to distinguish 2017, which was not so much amazing for the strong returns we got out of equities but actually just the low volatility we got out of those returns. And I think that was helped by what we were as Goldilocks phase: strong growth, low inflation, so liquidity conditions remained ample. This year we’ve clearly not had such a rosy start. We’re negative for the year across most markets and we’ve had a correction from the highs in June in equities by about 10%. So it’s not that they’ve taken everything in their stride. And I think what we’re now beginning to see is a realisation that a lot of the bad news that’s occurred is broadly priced. Things aren’t getting much worse, which is why we haven’t really seen a continued fall from the lows we’ve seen, so March we’ve bumbled around.

We’ve had much great volatility plus or minus 2% moves, compared to let’s say plus or minus 1% moves last year, so we’re seeing much broader ranges on intraday. And I think what we’re now beginning to see is the realisation that the Federal Reserve isn’t tightening much more rapidly than it’s already said. China has not really upped the stakes in the trade wars. It’s done tit for tat. But Xi came out and gave a speech, and he didn’t try and escalate the situation. And thirdly the things like the Syria conflict and the Russia sanctions, again over the weekend thankfully that didn’t escalate either.

So the market can now refocus back on the fundamentals, growth is OK, and therefore we can continue to think about generating some returns rather than focusing on the risks.

PRESENTER: So you’re pretty confident there’s not going to be a US/China trade war.

ALASTAIR BAKER: So I think what we try and focus on is what can we model, what can we understand? And that’s about thinking about what is the cyclical environment, what are the valuations? And then we think about what are the risks? So what we do is do some scenario work. So our base case is one of reasonably good economic growth, accelerating a little bit. Inflation also rising, but I would say, some people are talking about inflation getting out of control, we’re just talking about a natural normal cyclical pickup in inflation, which is broadly already reflected in asset prices. And around that we need to worry about the risks – because it’s about having a process to deal with these risks.

Because there’ll always be a trade war, a North Korea, there’ll always be something in markets that gets people het up, and it’s about how you analyse it, and how you control it within a multi-asset portfolio. I think the key about multi-asset portfolios: it’s about generating returns, but also trying to smooth that path of returns. So it is about thinking about those risks. In the case of the trade war, what our economists are telling us is that that will result in lower growth and higher inflation, clearly not a great outcome compared to our base case scenario. So we do need to worry about it. And what we need to do though is worry about and see how much we have to pay to insure that risk.

In Q4 last year we were still worried about trade wars, and what we found particularly interesting was the position in the US dollar versus Canadian dollar. Now trade wars didn’t start in March with China and the US; it started back with the NAFTA negotiations – the NAFTA negotiations, the North American Free Trade Agreement, so Canada in the north, Mexico in the south, the US. And Trump has been trying to renegotiate this. The Canadian dollar was very expensive compared to, because it had a good run of economic data, and there was nothing priced for those NAFTA negotiations. And what we’re looking for are those positions where the risks aren’t priced. So under the baseline we don’t lose too much money if that risk doesn’t come out, but under those scenarios we hopefully get a pickup. And that’s what we saw with the Canadian dollar, and we’ve taken profits on that position since.

PRESENTER: So, in summary, and looking at markets today, which are the risks that you think are well priced, and which are the ones that aren’t, either for good or bad when it comes to investors?

ALASTAIR BAKER: So I think the risk that clearly is not priced fully is this idea that the economy slows down. That’s the risk that I think that most people are comfortable with current valuations, given that we continue to get strong earnings momentum. I think to a large extent the Federal Reserve is now priced in rates. What isn’t priced yet, which is something that is concerning, perhaps the second half or first half of next year is what the ECB and the BOJ do, because clearly at the moment we’ve only got the US Federal Reserve withdrawing liquidity, what happens when the ECB and BOJ begin to participate in that withdrawal as well? But broadly speaking I think the market does reflect a lot of the risks now having had that correction.

PRESENTER: We have to leave it there. Alastair Baker, thank you.