At the Janus Henderson Global Media Conference, “New Investment Paradigm: Uncovering Opportunities and Challenges,” our senior leaders and key portfolio managers from around the globe shared their insights and outlooks for their markets. In this session, Director of Research Matt Peron and Portfolio Manager Andrew Mulliner discuss what they consider to be the key risks for equity and fixed income markets through the end of the year.
Louise Beale: Now it's time for reassessing rate, risks and reflation 2021 mid-year outlook and for this I'd like to introduce you to Alex Roitz, who is product specialist at Janus Henderson and he will introduce you to his panel on this. Alex.
Alex Roitz: Thank you very much. I'm pleased to be joined today by Matt Peron, director of research covering global equities and Andrew, Andy Mulliner, who is a portfolio manager, head of global aggregate. He covers fixed income. Andy, I want to start with you. Inflation, currently top of mind from many investors and we've heard a lot about it in the press, so to start would you share your view on inflation and then maybe specifically is this transitory or not?
Andrew Mulliner: Sure. Let's start with the big question which is, is it transitory or not. Our impression is that it probably is transitory but that comes with some pretty big question marks attached to it as well. The reason for thinking that the inflation we're seeing right now is mostly transitory is because much of it's being driven by the way in which we've had a very sharp closing of the economy in 2020 and a very sharp reopening this year.
What that's done, that's resulted in certain areas of the economy suffering from very significant supply constraints with raised prices but also, we've seen in broader markets like commodity markets, we've seen very big falls in commodities last year which have then reversed this year. That has the impact on a year on year basis, which is how inflation's reported, of driving these pretty significant inflation numbers.
So we think all that probably is transitory and falls through, basically falls away as we go through time. I think the open questions for us are around some of the longer-term and structural issues around labor markets, labor supply in terms of as the pandemic's changed the environment for labor, has some of the increases in minimum wages we've seen in countries like the U.S.; will that be sticky, will that persist through time?
Then of course the demand pick-up we've seen; we've obviously seen a big increase of savings as people have not had much to do over the last year. Will people spend that, will that demand surge persist as well? These are questions that we don't know the answers to but they're absolutely crucial in understanding whether the inflation that we expect will settle down back towards that 2% level the central banks are looking for or whether we're going to see a slightly higher level of inflation going forwards and that can drive perhaps one of these feedback loop situations that central banks are very concerned about.
But at this point, from our perspective, our money's on transitory.
Roitz: Right. Matt, let me give it to you: I know you see inflation as a big risk to the equity market. If inflation is in fact more persistent then what does that mean for equity?
Matt Peron: We have spoken about inflation as being the number one, two and three risk for the equity market so we're very keenly focused in on what DND has to say and paying very close attention. Why do I say that?
A traditional cycle ends with the central bank removing the punchbowl, tightening policy and ending the cycle that way so equity markets are very, very keen to find out when that cycle may end. They typically trade down six months or so before the end of the cycle and so if that's the way that this cycle is set up, which is to say it ends with a tightening of policy to stave off inflation, this question about transitory versus persistent is very important and so we're very focused on that.
To be sure, and especially based on Andy's comments just now, if there is an inflationary, a transitory backdrop, which I guess is our base case, then we have some time to go. The cycle certainly has room to grow on; a typical cycle is five years, two years after the first tightening event so we have some time to go in this cycle, especially under a transitory inflationary regime.
Roitz: Good. If I'm thinking about it, how important is a global mandate for an investor with this backdrop?
Peron: As an investor, having the global remit is very important for a number of reasons. One is that the different cadence of the cycles is helpful, it gives us more levers to pull. We can definitely source ideas from different parts of the world and ideas that might work at different parts of the business cycle.
But stepping back, I think having the ability to source innovation and ideas globally is really important and going to be more important going forward. For example in Asia we've seen a lot more innovation recently than we have over the past few decades and so that pace is really picking up and is at a quite rapid pace right now of innovation.
So we're able to get ideas there and source more investments that fit our secular themes, one of which for example is digitization. We feel that the digitization of the economy is really just hitting its stride and broadening out globally and that was amplified, accelerated by the pandemic. So we're able to look at ideas coming out of Asia in particular of late that really take advantage of that for their emerging economies.
For example recently we've invested in a really innovative company that's deploying blockchain in trade finance out of Asia so that's really exciting for us. We're seeing lots of those opportunities come to the for now.
Roitz: That's outstanding. Andy, I'm going to pivot back to you. What we've seen is that the biggest economies took on the biggest debts in 2020 but it's not a one-size-fits all; smaller economies saw the largest increase in debt relative to their GDP. So what implications does that have from the regional growth perspective?
I'm going to hit you with a second part of that: What impact does that have, or when do different central banks start to hike because of that?
Mulliner: It's a good question. Pretty much across the board we've seen very significant increases in public debt as a result of the pandemic as all governments have striven to rush to backstop the economy. Obviously how they've gone about doing it has varied quite significantly and I think that's a pretty significant factor to consider in terms of what the long-term ramifications are and it is those longer-term ramifications that the central bank are focused on, i.e., borrowing to fund productive investment, to future-proof the economy, is obviously much more productive and much more beneficial in the long run and also will allow the central bank to consider raising rates at some point in the future as well to offset essentially the increasing demand coming from the economy.
But for countries which have used that money in giveaways, if you will, perhaps not as productively as they might have done then obviously that's a counter to it. I guess you've obviously got a magnitude issue as well which is clearly if you look at places like the U.S. which have borrowed very significant amounts of money, it's very effectively provided a backstop to the U.S. economy and as a result the growth bounce we're seeing in the U.S. is very, very significant.
If you take some of the European economies, the size of the overall backstop has been significantly smaller so growth has been lower which has actually made debt to GDP look worse and also the recovery is going to be slower as a result of that.
So I think if you take those two factors into account you have very different outcomes as far as the central banks are concerned. Places like the U.S. are already seeing the central banks taking a far more positive view about the outlook to the economy. They're still very cautious and still very doveish in terms of their overall rate projections but you can see how they are on a pathway where at some point in the future they expect there will be hiking rates.
If we compare that to the European economy and the European Central Bank it's a very different story. Not only have you not got a very significant pan-regional fiscal stimulus package, when you consider the size of the European economy the next-generation new funding is actually pretty small relative to what we've seen in places like the US but you've seen a very different approach if we look at the countries themselves.
That just means that the structural issues that the ECB faced before when it came to achieving its inflation target are just amplified going forward, so it does actually have a very significant impact as far as central bankers are concerned.
In terms of the debt stability side of things I think central bankers generally see that as the second, third order as far as they're concerned. They're primarily focused on inflation and maintaining price stability but clearly debt sustainability should it become a factor would obviously be very significant in driving confidence in model investors to hold that country's debt but I think that's probably more of a side issue rather than the primary one at this point.
Roitz: Good. Andy, just sticking with you, would you share your outlook for fixed income on a go-forward basis?
Mulliner: Yes, sure. At this point in time we're still in a world where rates are very low and they're likely to stay very low for the foreseeable future. Growth is picking up, we're definitely in recovery phase and as a result we're seeing improvement in things like credit metrics so that makes us feel pretty optimistic still about corporate debt. Even though yields are relatively low and spreads are relatively tight the actual fundamentals are pretty good so we still think we're supposed to be playing for that sort of portfolio allocation.
From a government bond perspective it's a much more regional story. Again we still think that in the near term we don't expect to see a huge amount of action in the government bond markets. We've obviously seen a very big lift in government bond yields earlier on in the year. We think that will persist; i.e., we're not likely to see big falls in government bond yields but equally we don't see a significant rise from here as well.
So that leaves you very much in a world where you're optimizing for carry and fixed income portfolios so we do think government bonds actually offer some pretty attractive elements towards a broader portfolio because they represent two-tailed risk now. I.e., if the world gets worse than we expect government bonds can [unclear] that we are pricing in expectations that interest rates will rise at some point in the future, something that we weren't doing last year.
Equally though obviously we can get better growth and more significantly higher inflation outcomes and the market will have to adapt to it and that will obviously force yields higher but actually that makes them an asset class that's got some optionality to them for the broader investor.
So overall it's a fairly constructive fixed income outlook. It's just one where you have to temper your enthusiasm slightly because the reality is yields are low, spreads are relatively tight and there're still positive returns to be had.
Roitz: Fantastic, appreciate that. Matt, I'm going to pivot back to equities. You've done some work with the dividend index so can you give us a run-down of what happened in 2020 and then how about your outlook going forward?
Peron: Yes, 2020 was a very tough year for dividends so our global dividend index fell by 12%. That was very different regionally so in the U.S. and China for example dividends were fairly robust, fairly stable. In the U.S. companies were basically able to slow down buy-backs as a cushion so they didn't have to cut dividends as much so the way the U.S. market is structured it gave some cushion there for the dividends to sustain but the UK, Europe, Australia; it was very tough last year.
We see dividends coming back this year although pretty gradually so our expectation is that the global index recovers probably up about 5% as a base case for 2021. Again that's a global figure but again the pace of the recovery will be slow and gradual but we see it certainly starting to trend now in a very positive direction.
Roitz: Wonderful, very much appreciated. We're seeing some questions coming from the audience. I'll pivot there and the first one for you, Andy; how do central banks extricate themselves from the massive monetary stimulus? This is multi-parted. Are we in danger of another taper tantrum?
Mulliner: A very apt question given the recent FOMC announcements earlier on last week. I think to the first one, when can we exit this, I think the lesson over the last ten years is we're stuck with very significant central bank balance sheets. The chances that we're going to see those reduce in a meaningful way are pretty slight frankly at this point.
So I think extraordinary monetary policy has become, if anything, less extraordinary than it used to be and is now a common part of the toolkit. Interest rates are unlikely to rise absent of a major regime shift in inflation, which obviously we're not calling for at this point but we accept that this risks that.
That means that the balance sheet is going to be part and parcel of how central banks conduct policy going forward. So I guess the simple answer to the first part of that question is it's unlikely. We're sticking with extraordinary monetary policy for the foreseeable future, I would say.
Then you'll have to remind me of the second part of the question because I've forgotten it. Sorry.
Roitz: What are the dangers of another taper tantrum?
Mulliner: This is a really interesting question because the Fed has done everything it possibly can to avoid this outcome and in a way I think we're probably all guilty of it, the central banks are certainly guilty of fighting the last war and their fear of 2013 taper tantrum has resulted in them projecting out this very, very gradual withdrawal from extreme policy accommodation to perhaps just marginally less accommodation.
So I think in reality we're quite unlikely to get a taper tantrum similar to what we saw last time around. I think the bigger challenge for the Fed will be that the only way we're going to get a taper tantrum is the Fed suddenly has a massive pivot, in which case obviously all the guidance they've been putting out there works against them because they've laid the groundwork and then they've not delivered.
But assuming they do deliver their bigger risk is going to be perhaps they're going to struggle to get away to the monetary policy [unclear] they would really like to get to, which is probably a healthier level of rates simply because they're so cautious about causing a major market ruction so they've delayed for too long in a way.
So yes, I think it's a risk but it's a pretty slim risk from my perspective and certainly not something we're anticipating.
Roitz: Great. Matt, here's one for you. What are you hearing from company management, what are they saying about inflation and pricing?
Peron: Yes, that's a key question that comes up on management discussions; how is the inflationary backdrop that we're seeing, transitory or not, impacting margins, impacting their ability to raise prices, etc. In general – it's hard to generalize it but I'll do my best – managements are seeing price increases. Many of them are able to pass those prices through. Some are absorbing them so it's a little bit different industry by industry but it's certainly something that is very acute for them and an issue that's top of mind.
On the wage side interestingly they have said that the wage pressures have been manageable so, yes, there have been some wage pressures but they've been more manageable than actually the supply of labor, which has actually been the pain point for them so just getting the workers right now is harder than actually absorbing the costs there so that's something that we'll have to see in terms of how the labor market supply comments that Andy made earlier play out. Those are going to be very important and something we're staying on top of with our company and management.
Roitz: Excellent, appreciate that. Here's one for both of you and maybe you can each chime in. Outside inflation what are the tail risks that you're worried about and is there anything you can do to protect or what are you doing to protect against them?
Mulliner: Shall I go first? I guess the reality is the big tail risk is a bit of an obvious one because it's still COVID at the end of the day and the reality that we are very much building our expectations around the outlook on the new idea that this will be contained and we'll move forward but I suppose one of the lessons of the last 12 months has been to temper your enthusiasm when it comes to all the projections around this virus because it tends to stick around longer than we anticipated.
So I think the big downside risk is actually that this return to normal is even more extended than we had initially anticipated and therefore that slows the recovery as well. Obviously central banks have responded generally so I don't think markets are too concerned about it but nonetheless that is a source of concern.
At the risk of hogging the mic, the other area where I think probably most market participants are guilty of spending a lot of time worrying about without necessarily understanding how it's going to impact has to be the geopolitics right now and it's related to COVID.
Obviously the state of relations between China and the rest of the world, particularly the developed world is probably, certainly over the last ten, 20 years, at its lowest point and that's obviously a point of concern for investors given the significance of China for the global economy and also the significance of China within global supply chains, etc.; we've already discussed the risks that those pose.
So I think there's a geopolitical angle here that we should be aware of and there's obviously the virus which is perhaps the obvious one.
Peron: The only thing I would add just from an equity market perspective – I think Andy covered off the main global issues – is fiscal policy; particularly tax policy could be a headwind for equities and a too aggressive policy there could derail some things although again that's not our base case but that's a potential risk.
Mulliner: If I can follow up on that, that's a good point. I think when we think about what's changed, when we're thinking about the structural regimes that we're investing in, what has changed, what could the pandemic have changed, fiscal policy in the U.S. is certainly something that is different today than it has been for the past decades quite frankly. Whether it sticks or not is hard to say because you have mid-terms, etc., and people get to vote on this stuff pretty regularly in the U.S. but nonetheless it poses significant risks, I think, to the way we think about the structure of the U.S. economy and perhaps some of the trends that have been in place for the last 30 years so I think that's something that's a very apt point.
Roitz: Wonderful. We're down to just about 30 seconds so maybe just a quick hitter for each of you: COVID draw-down. 2020 was very uncertain. Was there anything that surprised you outside of the obvious in 2020 and how markets reacted? 30 seconds.
Mulliner: The degree to which we've been conditioned by the central banks to respond accordingly. It was on cue and very quick so that was surprising, I think, to some degree.
Peron: Yes, I'll echo that one. I think we're out of time for more but that probably ties with mine.
Roitz: That sounds great. Gentlemen, I really appreciate your time. Thank you so much. Louise, I'll hand it back to you.