Markets are heading for a volatile stint in rehab over the next five years as they are forced to kick the liquidity drug they’re addicted to, according to RWC’s Nick Clay.
The apparent inability of markets to operate without being constantly fed liquidity by central banks is currently the main concern on the veteran fund manager’s mind as he re-launches his Global Equity Income strategy at RWC Partners.
His unexpected departure last year saw his entire team move over to RWC Partners. The RWC Global Equity Income fund was re-launched at the end of last year with the exact same process and investment team as his former BNY Mellon offering.
Preparing the RWC Global Equity Income fund for launch, Clay said he had been able to sit back during 2020 and gain some perspective on what was going on in markets without being “sucked into the day to day noise”.
The main thing worrying him the most is how reliant markets are on liquidity and support from central banks – “addicted”, as Clay put it.
He said: “I think Seth Klarman put it perfectly, it's like a 30-year-old millennial who could never survive on their own two feet without their parents’ help. Well, that’s just like the market.
“The market seems to be completely addicted to the liquidity pumped out of central banks. It’s almost like a drug for the markets and it can't survive without it. And that is an unhealthy situation, because we can't just keep pumping out liquidity all the time again, and again.
“We’re going to have to work out how the market can stand on its own feet. That will be a volatile transition, a bit like coming off a drug.”
Clay is expecting the next five years in particular to be a much more volatile period for investors, more than what they’ve been used to in the decade-long bull market since the financial crisis.
“And I think that's something that a lot of investors are just not used to. They expect to be bailed out every single time and why wouldn’t you because that’s what we’ve become used to,” Clay said.
“I think that’s the biggest risk currently, and eventually FEMA will not be there with food anymore for it and that's going to be a problem.”
Another consequence of central banks beginning to turn off the flow of liquidity is inflation, a current concern for investors. But Clay thinks that it will have its strongest impacts in the short term as there are still a lot of deflationary forces in effect.
He said: “What I find interesting is that all the forces which were disinflationary before we went into the pandemic still exist. In fact, some of them have become even more extreme.”
Factors such as ageing demographics and the amount of debt have increased in the past 12 months, with the latter going up “astronomically”, particularly at the government level.
“We know, and it's kind of been demonstrated, that too much debt is a disinflationary weight put upon economies and prices,” Clay said. “None of that has gone away.”
He added the technology theme has accelerated massively over the past few years and during the pandemic and is now disinflationary force working at “full throttle”.
“It just comes down to surely we're going to get inflation because we're printing so much money, throwing so much money [at the economy],” he said.
“I think, yes, short term that will happen but after that when we start to dial down and turn the taps down then you're not going to have that tailwind in the background. So I think inflation will peak and then come back down quite quickly.
“Now I could completely wrong about that obviously, because I have no idea what the future holds.”
If structural inflation did begin to push through markets - led by wage inflation – Clay said he still doesn’t think this would cause a rise in interest rates.
“And the reason why I say that is that the people who set interest rates are the government, and the government has all the debt. And quite frankly, the government can't afford interest rates to go up very much,” he explained.
If interest rates were to go up governments would be left with an “unsustainable credit card bill to pay at the end of every month”.
Overall, Clay expects ‘normality’ to resume, despite markets inferring that the current events and fears are permanent.
“I think human beings are quite predictable creatures, and I'm no different from that,” he said.
“And therefore, the response that we saw to the pandemic was pretty typical actually, something that repeats through time. Every time we've had a crisis what the market tends to do is extrapolate the now forever.
“So 9-11 we were never going to fly in planes again and we were never going to build tall buildings. Again, the global financial crisis, no-one's ever going to take on debt again, it became a ‘four letter word’, and obviously, that was complete rubbish.”
This time around the thinking is that people will permanently remain working from home with ongoing social restrictions and a massive focus on infrastructure investment and spending.
“Therefore the market immediately extrapolates that as that's going to be the continuation forever. And we just know from history, that's just not true,” Clay said.
The one lasting impact Clay highlighted from the pandemic was an increased awareness and drive to tackle the social inequalities which had worsened in the past year.
“I think the real genuine lasting effect is, that [in] the financial crisis we saw the rich get richer and in the pandemic we saw that go and accelerate because again the stock market was pushed immediately back to all-time highs,” Clay said.
“That took seven months, whereas the global financial crisis to the seven years, the tech bubble it took seven years, and therefore [a] very narrow part of the population of society really benefited again. And I think you combine that with the other events that are going on in the world from Black Lives Matter, the ESG and climate change people are finding their voice, they now know that this is unacceptable, and they can do something about it and politically that's become something that's important I think that is a structural change.
“Everything else, I think we'll just return to normal, but the market loves to extrapolate [the] now forever, like they're doing with infrastructure spending today.”