Multi-Asset with David Vickers, Russell Investments

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  • 09 mins 09 secs

David Vickers, Senior Portfolio Manager at Russell Investments, discusses the current stance on the US and China trade war, the weak start to the year for Europe and the likelihood of a US recession.

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PRESENTER: Joining me now is David Vickers, Senior Portfolio Manager for Russell Investments. So, David, it’s good to have you with us today.

DAVID VICKERS: Thank you.

PRESENTER: So let’s start with the trade war, and what’s next for Donald Trump and Xi Jinping?

DAVID VICKERS: I think to work out where we’re going perhaps if we recap where we’ve been, and see where the trajectory is. So we started in April with a tit for tat $50bn worth of tariffs. We have gone onto President Trump announcing £200bn worth of exports at a 10% tariff rate, going to 25% if negotiations don’t progress by next year, and then a further tweet or threat of another $267bn of exports being taxed, which would be the entirety of the Chinese export markets to the US. In terms of where we go next, they are due to sit down and talk at the G20 meeting. We also have the negotiations that are undergoing outside of those main events. My instinct is that the tariffs that are in place will stay in place. I think it’s possible some conciliatory moves are made, like we have seen with the agreement formally known as NAFTA and the other trade agreements.

But I have to say I think what’s happening now is the start of a new paradigm shift between, or the relations between China and the US. China has very publicly stated its ambitions and its plans, and ultimately that means challenging the dominance that the US has enjoyed for a very long time. And Vice President Pence talked about it as being the great competition for power. So the current trade talks that we’re talking about and the tariffs are a concern for markets. I think actually they’re price in to a certain extent now, given that emerging markets after last week’s falls are now peak to trough 26-27% down. So in the short term they’re priced in. But longer term I think these, the frictions will continue, and I think it moves away from being just about trade.

So last week we had rather scarily a Chinese and a US warship coming within 45 yards of each other and having to avert. We had yesterday again President Trump talking about the Chinese no longer being able to benefit from the postal service and the subsidies that they have historically got. All of these things add friction to global trade.

So, in terms of what does that mean, I think temporarily the markets have adjusted to the current trade regime and the current combative stance. So short term I think we’re OK. But I think longer term if these frictions persist, and they have to persist or manifest themselves in a way such that economic growth is slightly lowered, because that’s what happens when you have friction in trade, and we have ultimately a higher cost of goods to the consumer, so a more inflationary trend. Now at the minute that is going to be passed on to consumers, at some stage that takes a hit to margins. So all of this I think is a world we’re going to have to get used to in the coming five, 10, 15 years.

PRESENTER: Well, over to Europe now, and a weak first half of 2018 for Europe, but how do you see the rest of the year playing out and indeed beyond?

DAVID VICKERS: It’s very easy to put European equities specifically in the hard to manage bucket, because as you rightly say investors have been fairly perennially disappointed, at least in relative terms to other equity markets. And this is despite the fundamentals being pretty good. You have cheaper valuations, you have lower margins. You have reasonable economic growth that’s now starting to surprise on the upside. We’ve had good earnings. We have an accommodative monetary policy with super low rates relative to the rest of the world. And yet, as you say, European equities have persistently, or at least over a long period of time underperformed certainly the US. To my mind it’s been held back by a whole host of exogenous factors which have really killed the sentiment and the flows toward Europe. Particularly when you speak to investors in the US, they have the slight attitude of why bother, particularly because their market is doing so well.

So we had Trump and trade again, and clearly the emphasis towards the European autos caused consternation for some of the manufacturers. We then rolled around to the emerging markets issue, and emerging markets are a bigger source of revenues and growth for Europe than they are for the US. We then had Turkey and the contagion fears, and more recently we had Italian banks and Italian budgetary concerns. There is always, there has always been a shock. And so actually when one looks back over time, certainly since 2014, Europe has actually delivered the same amount, or relatively the same amount of earnings, of dividends and of dividend growth of the US, but has spectacularly failed to re-rate to the same tune; hence the underperformance. But it’s actually delivered. And that’s why it’s quite easy to put it in the slightly difficult want to put more in, because it hasn’t performed.

But if you believe, like we do, that those fundamentals will eventually out, because the value does outperform over time expensive stocks, then we think you should have weightings to Italy. The coast looks relatively clear going forward. We don’t think the Italian situation is a game changer, although it certainly is a watch point. The only thing I would say is that if one’s making the call between Europe and the US, one has to be aware that they’re not quite the same. It’s not quite apples with apples. If you’re being reductionist you’re boiling it down perhaps to European banks versus US tech. So what I would say is if you do believe in the tech sector, and growth that is there, actually take that separately, but if you have a European stock and a US stock that compete in the same industry, and one is much cheaper and has those fundamentals we’ve discussed, then you should put your money into that stock as opposed to the US counterpart. But just be cognisant that it’s not quite apples with apples.

PRESENTER: Well you mentioned the United States, now there has been a lot of noise about a potential US recession, so have the risks increased for this?

DAVID VICKERS: The clamour certainly has. And it’s interesting that I think amongst economists and market practitioners those risks and those noises have increased. But to investors it’s quite difficult to comprehend, because we’re talking about recession risks coming forward at a time when US growth is very strong, unemployment is very low, and those trends are moving up and falling in the right way. We have inflation, but a moderate amount that is still currently under control. We have super earnings growth. At peak levels we have margins that are not yet coming down, and we have capex year over year that is going on to about 20%, so a really nice good environment. And so it seems a little odd that we should be talking about recession. The problem being that as Mr Powell pointed out, economic growth comes at a cost, and the cost is higher rates. And that’s where the recessionary balance comes into tilt.

So currently next year there is two-and-a-half rate rises forecasted by the market. We have the same view, but we actually think there might be upside risk to that if growth continues to be strong. And that puts monetary policy into restrictive territory, from being accommodative to being restrictive to combat inflation, and to temper growth. Now it doesn’t necessarily mean as you move into restrictive policy we enter recessionary territory, but you start to move towards that. Because restrictive policy cools growth, cools unemployment, cools capex and so on and so forth as to when you enter the recession. And as we get stronger economic growth, those recessionary probabilities have to come in a little bit because of that very clear dynamic.

I guess the other adjunct to that is if and as we get higher interest rates, we’ll probably get a stronger dollar, which puts more stress on emerging markets, so the global economy looks a little weaker at the same time. But it all stems from that potential higher rate scenario, which actually offsets all that very good growth that’s coming through. But we don’t think today. It is a storm clouds are gathering, and they’re not above us just yet, so we do think there’s runway, particularly after last week’s falls in equity markets and risk assets to make some more headway in terms of return, but those clouds are certainly coming forward.

PRESENTER: So finally what does this all mean for portfolios?

DAVID VICKERS: I think the things we’ve talked about are quite long-term things. The gyrations, the volatility, the down drought quite frankly that we had in equity markets last week have provided an opportunity to reload the gun if you like. So our portfolios today are back overweight risk and underweight duration following a period where we were slightly under. And these present in volatility are going to create that opportunity for investors. 2017 has gone. We aren’t going to get the very steady smooth path with no volatility, as rate rise, as volatility comes in and thoughts of recession and Trump and trade come into manifest we’re going to get volatility.

But today as we speak it makes sense to maintain an overweight position to risk. But not as overweight as we have been historically because we know that those storm clouds are gathering, and being very candid we don’t know exactly when they’re going to, the storm clouds are going to open, and so we’re less overweight than we have been historically because the runway is a little shorter than it has been. But at least today we’re overweight risk assets, using convertibles as we’ve always done as that way of capturing that asymmetry in markets, and today underweight duration following the selloff in markets.

PRESENTER: Super, David, thank you.

DAVID VICKERS: Thank you.
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