Newton’s Iain Stewart is taking a “very cautious” stance in the Newton Real Return fund on the view markets are facing “a central bank sponsored asset bubble”.
Speaking at the Morningstar Investment Conference, Stewart says the £10.2bn absolute return fund’s net equity exposure is currently low at 20 per cent, reflecting his concerns on what is driving the markets when global uncertainty is prevalent.
Leaning on quantitative easing
Although quantitative easing was intended to inflate asset prices, creating a wealth effect to drive spending and thereby growth, Stewart says: “We never felt it would work in that way. It was meant to be temporary but has ended up being semi permanent. There has been continual support for the markets, but the actors have changed.”
Stewart says that “perhaps it is no coincidence” that when central bank support fell to “almost nothing” in January/February 2016, that was the low in global equity markets.
With easy monetary conditions prevalent, Stewart says: “Central Bank interventions won’t always work, or be a road map, but it looks like a convincing reason for why we’ve had this euphoria in the markets…Lots of investors are conditioned to receive this support, and that encourages them to take more risk.”
All in the price
As such, he adds that valuations are now key, with the potential for negative returns on the horizon.
“If you pay a lot, you’re going to get a lower return….If you pay 29x earnings, you’re expecting a return of 1 to 2 per cent, not that far away from a government bond yield…That suggests the probability of negative returns is relatively high. That has led us to be very cautious in the running of the strategy…We’re probably in another bubble.”
He adds: “The view is that we are going to normalise, that we have passed through the three waves of the crisis [in the US, Europe and emerging markets] and we are looking at new normal growth, and that we’ll grow into these valuations. But we aren’t so sure.”
The four ‘D’s
Stewart says he is concerned about the four ‘D’s in the US: debt, disruption, demographics and distortion.
He says total debt is now 45 per cent higher than in 2007 at $163trn, adding that debt creates liability and is a drag on future growth.
There are also pitfalls to technology disruptors, Stewart says. “Many have fantastic capitalisations and don’t necessarily follow the same profit motive. Uber is destroying huge profit pools but is not generating a profit itself.”
Demographics meanwhile are proving detrimental to the labour market. “The median baby boomer is now aged 62. We are not seeing much growth in the working population. We have never seen demographics like this.”
On distortion, Stewart adds: “We are seeing the distorting effects of extraordinary policy measures. We have created a highly financialised economy”.
However he says the current cycle – among the longest bull runs seen – is in its late stages, with underlying profits past their peak.
Outside the US, Stewart says China “is a risk in the way its financed”, largely through credit.
“Half of the world’s credit growth is in China, and it is not all productive investment. It is reflected in the growth in China’s banking system. China’s economy is 40 per cent of the size of the US economy, but China’s banking system is twice the size of the US banking system.”
In the Real Return fund, Stewart is focusing on traditional asset classes and the “return-seeking core”.
“I feel stupid targeting an upward-only return, but we feel it is relevant in this environment,” he says. “I use a car tire analogy. When valuations are attractive we can operate with a low profile. When the backdrop is difficult we can wrap a bubble around it. It means we are hedging a lot of the returns away, which has been the case for the past two years. We try to focus on a sustainable yield.”
Stewart adds that US treasuries, which represent 18 per cent of the portfolio, continue to act as “quite a good hedge” for risk assets. “If we’re wrong and US short rates rise further, we are still picking up a nice yield,” he says.