Q&A: Hopes for the second half

Bill McQuaker insists the world economy is now relatively benign. Markets, he tells Philip Scott, are boosted by a degree of security emanating from central banks


How do you view markets right now?

From our perspective the world has been a relatively benign place. Central banks, especially in the second half of 2012 made it clear they would be willing to go the extra mile to help stimulate the global economy. It is a kind of ‘Goldilocks’ world we have been living in. For sure, since 2010, global growth has been disappointing but in our opinion we have not had a world that has been so fragile, that there is a real danger of it falling into recession. So, the porridge may not be as hot as some would have liked but it is still warm enough. This has been a positive for markets, because there has been endless re-assurance from central banks, that if data disappoints, they are ready to provide fresh stimulus. That is quite a good situation for markets to be in.

But where do the real risks in all of this lie ?

The US economy is still performing reasonably well. There is a decent chance the US will have reasonably strong second half [of the year]. In Japan too, the economic data coming through has been quite positive. It is not beyond the bounds of possibility both will have a better second half. Maybe even Europe could deliver a modest surprise on the upside. If this all happens, markets will have to face the fact that quantitative easing could be turned off or reduced. Any suggestion of that on the horizon would be disruptive. In the last few weeks we have woken up to this possibility, witness the sell off in fixed income and emerging markets. If there is a growth shock in the second half of the year there would certainly be some further adjustment required in bond portfolios and probably in equity portfolios too.

You have recently upped your exposure to commercial property, why?

If the world economy continues to heal, policy will become less accommodating and bonds will have less appeal than they have had. The bond markets are going to struggle with liquidity if a large weight of money exits. As a result of this, we have moved some bond exposure into commercial property. Commercial property does not look too exciting an investment but if we can buy some, with a 4.5 per cent yield, this will provide some inflation protection. We are not expecting commercial property to deliver really strong performance in capital growth terms but we would not be surprised if it delivers get 4.5 to 5 per cent yield over the course of a year. In the current climate that is quite an acceptable return for part of the portfolio.

You have not bought massively into the emerging markets story, why?

We are underweight emerging markets, as well as Europe and Asia. Some headwinds are making it difficult for emerging markets to outperform and at the same time there are fresh developments in other parts of the world, which will drag investors away from developing markets. Some of the fundamental advantages they had 10 years ago, for example weak currencies and cheap labour coats, these advantages today lie elsewhere. The US dollar has been falling for 10 years and Mexico, Spain and the US all house cheap labour costs today.

We are not that concerned about the growth outlook for emerging markets, our expectation is that they will generally continue to grow at faster rate than the rest of the world. But in the past decade investors have bought very large holdings in global emerging markets. Those who had one to two per cent exposure in 2001, may have some 15 to 20 per cent allocated today. I believe the global emerging markets story has matured and it is unlikely to be a big driver of performance over the coming years.

Where do you see the future drivers of growth coming from?

We are presently overweight in the UK, the US and Japan. The US has the strongest underlying fundamentals. There has also been a cleansing in the banking system and a recovery in the commercial and residential property sectors. The Japanese government is doing everything in its power to bring an end to deflation. It has a huge quantitative easing programme waiting to unfold. There is also a programme of structural reform, to liberalise some industries, which historically have been very heavily protected. For example agriculture is heavily protected from overseas competition however the government gets a lot of its support from the countryside, so it is nervous about letting in overseas competition. The Japanese consumer would welcome better prices but farmers would not. But trade agreements are being worked on between a number of Asian countries and the US. And Japan wants to be part of the negotiations and put agriculture on the table. This gives some confidence.

Europe has been the most challenged part of the world, which could also attract the most capital. The S&P 500 has hit new highs but the Euro Stoxx 50 would have to double to get back to 2000 levels. But there is a valuation and profitability argument which favours Europe. The issue is will fundamentals change in Europe to allow this potential to be released?

Where does the UK sit amongst this?

The UK is in better shape than the newspapers would have us believe. There is no question that since 2010 the UK economy in aggregate has barely grown, it is certainly not in rude health. Europe is one of our most important trading partners, and its woes have had a knock-on impact. North Sea oil output has been declining in recent years, which has hit GDP growth. But I feel there has been a tendency to underestimate the importance of the last budget, in regards to the Government’s ‘Help to Buy’ initiative aimed at aiding people to get on the housing ladder, where loans for those putting down 5 per cent deposits would be guaranteed. The potential of this is quite significant as it could free up a lot of cash.


Bill McQuaker is the head of multi-asset & deputy head of equities at Henderson Global Investors.