A likely uptick in inflation and the prospect of further stimulus should set the bull run on course for one final surge, according to Peter Spiller, manager of the Capital Gearing Trust – but it is not one he intends to participate in.
Spiller said that it would be wrong to look at the global financial crisis of 2008 as one that has been solved – pointing out the crash was caused by excessive debt, which has risen from about 200 per cent of global GDP at the start of 2008 to just under 250 per cent today.
He added that one of the problems with having this amount of debt is “you can’t have a downturn”.
“If you have a downturn with this much debt around, there is a real danger it will spiral into something worse,” he said. “And the really important thing about that is it means central banks will do everything to stop there being a downturn. Even in China.
“China, if you remember, in 2009 added the most fantastic level of stimulus to get its economy going. And actually it stimulated the whole world, but that involved adding a lot of debt.”
“So, I think we will get very rational behaviour by central banks.”
Debt-to-GDP ($trn/per cent of GDP)
Source: International Monetary Fund
Spiller noted the change in central banks’ balance sheets since February 2010, which he said “more or less explains the moves in the S&P [500]”.
He added that while the stimulus is now behind us, the good news is that if he is correct, “any hint of a downturn will be met by much more expansionary monetary policy and we could well have one last gasp here of markets running”.
However, the US and global markets do not need to rely on further monetary stimulus to see an uptick in inflation.
JP Morgan Asset Management global market strategist Alex Dryden pointed out the Federal Funds Rate has consistently trailed the Taylor rule – which measures the appropriate level of short-term interest rates by looking at current inflation and the capacity of the economy – by around 250 basis points for the rate-hiking cycle.
Spiller said that from looking at how previous financial crises were solved, inflation appears to be the most likely method that the US will choose to deal with its debt burden, adding there is even a close parallel with the past suggesting this measure is soon going to start moving higher from its current level.
Effective Federal Funds Rate since 1955
Source: St Louis Federal Reserve
“When Lyndon Johnson came into the White House [in 1963], he had one great aspiration which was to help the poor, but he inherited the Vietnam war and both of these were very expensive,” the manager continued.
“He did not give in and tax the American population, he added tremendous fiscal stimulus to an economy that was already fully employed. And the result of that was inflation which was between 1 and 2 per cent the previous five years just built by about 1 per cent a year until it was about 6 per cent until the end of the decade.”
He added: “So I think the thing about inflation is that if we’re right, it will change the price of financial assets. And if we’re wrong, that wrongness is already priced into markets.”
However, Spiller said he has no plans to increase his equities exposure, which currently accounts for about 10 per cent of the portfolio. He has not always been this risk-averse – the manager said that when he took charge of Capital Gearing Trust in 1982, investors should have made a 16 per cent compound real return for the next decade.
“We did a bit better than that but the opportunities were fantastic if you went long duration. The longest duration you can have is equities and we were all equities,” he explained.
“But I am sorry to say today there is really very little indeed that can be described as good value in terms of total returns and risk. And therefore we are more defensive, shorter duration than we have ever been.”
Instead, he has 25 per cent of his money in US TIPS (Treasury inflation-protected securities) which he said “in a world of really poor value are probably the best value asset”.
“They have a positive yield of just over 1 per cent and that compares with a UK yield of -2 per cent which is similar to the yields throughout Europe,” he added.
“What we are hoping is, when we get that radical response from central banks, they will go back to negative yields, giving a very significant capital gain on that asset, at the same time obviously as other assets are going down.”
Data from FE Analytics shows the Capital Gearing Trust has made 429.41 per cent over the past 20 years, compared with 279.4 per cent from its FTSE 350 Equity Investments benchmark and 208.97 per cent from the average trust in the IT Flexible Investment sector.
Performance of trust vs sector & benchmark over 20yrs
Source: St Louis Federal Reserve
Capital Gearing Trust is currently trading at a premium to net asset value (NAV) of 2.2 per cent compared with 1.96 and 1.61 per cent from its one- and three-year averages.
The trust has ongoing charges of 1.14 per cent and is not currently geared.