With developed economies seemingly on the road to recovery after the global financial crisis, a number of industry experts – such as Old Mutual’s Richard Buxton – have said that investors will enjoy a prolonged bull-run over the next 10 years or so. However Stewart, manager of the £9bn Newton Real Return fund, says that there is no recovery going on but a massive asset price bubble being inflated.
“We do think we are mirroring the last cycle but this time the authorities are tackling structural issues with monetary policy,” he said.
“Basically, they are tackling huge amounts of debt with more money. This will inevitably create a bubble.”
“The problem is; there isn’t a “plan B”. If all this QE doesn’t work, they will just have another bout of it.”
“These guys actually believe that these policies can work and unless they junk these, basically, religious beliefs about QE, it is going to continue.”
Stewart says that any investors who think the current environment is reminiscent of the early 1980s, which was the start of multi-decade bull market in both equities and bonds – are deluded.
“We now exist in a world of lower than average returns, but higher volatility, than investors had got used to in the great bull market of the early 1980s through to the 2000s,” Stewart said.
“How can we really be sure that that is the case? The reason why we are sure is because of the situation regarding the current starting point.”
“The key to return is the price you pay and, however you cut it, the starting point here doesn’t look very auspicious with rates even lower than they were then, with valuations and margins at very high levels and with the demography looking really unattractive.”
For instance, Stewart says that in 1982 the US Federal Reserve’s funds rate [the interest rate at which US banks lend to each other, equivalent to LIOBOR] was 12 per cent and 10 year US Treasuries were yielding 12 per cent. Now, however, the Fed funds rate is 0.25 per cent and treasuries yield 3 per cent.
The manager also points to the fact that in 1982 the P/E ratio and the cyclically-adjusted P/E ratio of the S&P 500 were 7.7 times and 7.8 times, respectively. Those figures now stand at 18.6 times and 25 times respectively.
Stewart blames these artificially high valuations on huge intervention from the world’s central banks and says that if this remains unchecked it could cause a massive problem for investors.
“What we have is increasing risk, both economically and financially, but with a lower expected return. For investors, that isn’t a good combination. In fact, it’s one you really want to avoid.”
Investors in risk assets have been very well-rewarded since the period after the financial crash.
According to FE Analytics, since global equity markets bottomed in March 2009, the MSCI World index and the Barclays Global High Yield index have both returned more than 100 per cent.
Performance of indices since Mar 2009
Source: FE Analytics
However, Stewart attributes the majority of those returns to quantitative easing from the world’s central banks.
“It’s almost a case of ‘here we go again’,” Stewart said. “The S&P is hitting all-time highs and many other markets are doing the same thing. It is possible this cycle is just tracking some of the previous cycles.”
“Our view is that these sorts of policies [QE and ulta-low interest rates] are not effective in creating real economic growth but are very good at winding up asset prices.”
“They seem to be the most palatable option for central bankers and so it could be an extended situation and because of that some of the biggest bubbles of all-time could be being created here.”
While the manager has little idea what will cause these bubbles to burst, he has told FE Trustnet in the past that this doesn’t mean investors should just ignore the problem.
“A lot of people suggest there isn’t anything as obvious as there was in 2008, but it could be that that it is just a lot more widely spread,” he said.
“There are some pretty egregious valuations in the equity market – internet retail, for instance – but that speculation and leverage is now entering into credit markets and so the bond market itself could be the biggest bubble of all time, but who knows?”
“With interest rates this low, it [the bubble] could get rather large.”
FE Alpha Manager Stewart has run his £9bn Newton Real Return fund, which sits in the IMA Targeted Absolute Return sector, since March 2004.
Our data shows that over 10 years the fund has returned of 120.76 per cent but with an annualised volatility of 8.96 per cent. As a point of comparison, the MSCI AC World index has returned 111.91 per cent over that time.
Performance of fund vs indices over 10yrs
Source: FE Analytics
It has also delivered a positive return in every calendar year over that time, except in 2011 when it lost 0.75 per cent.
The portfolio is split into two different components. The first is made up of core “return seeking assets”, which at the moment are equities, corporate debt, infrastructure and convertibles.
The second is made up of hedging positions such as cash, short-dated bonds, gold, currency hedges, equity market options and fixed income options which are used to insulate the portfolio and mitigate risk.
Stewart says that his weighting to these “hedging positions” is at its largest for some time.
While this means the fund has lagged in the recent rally, Stewart is happy to give up on short-term returns in the hope that he can protect his investors when the bubbles, he describes, start to burst.
Newton Real Return’s clean share class has an ongoing charges figure (OCF) is 1.11 per cent.
