Excess liquidity provision, ongoing issues in China and weak global growth are just some of the reasons that Tilney Bestinvest remains bearish as we head into the New Year, according to Gareth Lewis.
The chief investment officer, who oversees £9bn of assets at the firm, says there are global headwinds casting shadows over markets that are hangovers from 2015 as well as from previous years, and as such is cautious going forwards.
He has therefore pursued a position in gold for what he says is the first time in his career in investment management, a call that is controversial given the poor performance of its price over the last three years.
Performance of gold price over 3yrs
Source: FE Analytics
In an article published last week, a panel of investment professionals including Apollo’s Ryan Hughes warned that, despite cheap valuations, investors should hold off from buying into gold at the moment.
“For 2016, there looks to be a continued headwind from the strong US dollar that could certainly keep the gold price depressed while a continued slowdown in China is also likely to act as a headwind,” Hughes said. “Traditionally, gold should act as a safe haven in times of turmoil but time and again through 2015, gold failed to live up to this billing and didn’t protect capital during the numerous sell-offs that occurred.”
However, Lewis (pictured) believes the dollar won’t necessarily remain strong throughout 2016 and that economic data from the US isn’t as strong as it appears to be because positive employment data has warped people’s perspective on the country. 
“The other reasoning behind [holding gold] was this perception that we’re going through a period of currency risk,” he explained. “It’s not just the Japanese, it’s not just the Europeans, it’s not just the Americans, it’s also the Chinese – they’re very worried about currency.”
“In a world of what could be perceived to be competitive currency valuations, you want to hold a store of that. Gold was put in as a portfolio insurance policy against the fact the dollar may unwind.”
Lewis admits that this position, which was added last year, didn’t pay off initially but says that it has seemed to work well over the last six weeks.
The CIO says Tilney Bestinvest also reduced its equity exposure several times throughout the course of 2015 in favour of cash as a result of the firm’s cautious outlook.
“A lot of people don’t like cash but we actually view cash as an excellent store of value in an environment where economic and corporate environment looks stressed, so we’ve increased our weightings,” he said.
“This has partly come from [equities in] Asia, emerging markets and the US, but the other reduction was actually made was in Japan.”
“We did have quite big positons in Japan going into last year which were hedged against the yen. We’ve reduced that exposure over the course of the year.”
There are several reasons why Tilney Bestinvest has become more bearish in 2016, but one of the biggest factors is that banking deregulation and Federal Reserve monetary policy have driven a 15-year “liquidity glut.
“We think a lot of people are not seeing what’s going on that clearly because they’re not putting the events of the last five years into a long-enough context,” Lewis argued.
“Everyone almost views 2008 as ‘year zero’ and that everything we see is caused by 2008 whereas it was actually a symptom and not the cause.”
The CIO believes that the financial crash was sparked by long-running issues caused by excess liquidity, which have been skewing asset prices over the last 40 years.
“If you create excessive levels of liquidity over a short period of time, some and possibly most of that liquidity will be misallocated because it needs to find a home quickly,” he explained.
“Quite often, the home it finds with the benefit of hindsight looks pretty dumb, but you won’t know how dumb it is – US housing is a prime example of that.”
“My view is that China is the current one and that in 2008 the liquidity that was created by central banks has largely flown to the parts of the world that were showing growth signs, which at the time was China and Asia.”
“The amount of liquidity that has gone in that direction over a short time makes it absolutely clear that a lot of this could be misallocated.”
The reason he feels this problem has become more extreme this now is that 2008 was sparked caused by a solvency problem as opposed to a liquidity problem and that central banks artificially supported asset prices with liquidity as opposed to clearing the solvency issue outright.
This, he says, created the illusion of a recovery which, if an investor were to dig deeply, would find never existed.
Lewis is also particularly worried about the health of China’s economy, which has divided opinion over the last few months as to how much it will impact UK investors.
Following extremely high levels of growth and a subsequent strong performance of the Shanghai Composite index in the first half of last year, the bubble eventually popped in July, causing a global sell-off in August that has since been dubbed ‘Black Monday’.
Performance of indices in 2015
Source: FE Analytics
“The big capital misallocation story is China. To put this in context, China has poured more concrete since 2008 than the US poured in the whole of the 20th century. That is a staggering volume, and if you look at the way in which the Chinese economy has grown over the last five years, it’s clearly unsustainable,” Lewis said.
“The way in which they responded to the decline in Western markets in ’08 was to increase leverage very significantly and to use that leverage to fund infrastructure projects. This is a country that is already developed in virtually every sense that we are. Shanghai is considerably taller and more modern than London now.”
“There have been huge developments in China and yet we still call it a developing market. It’s not, it’s the world’s second-largest market and it really does not require the infrastructure spending that’s taking place.”
The other problem being caused by China, according to the CIO, is that capital allocation has gone to state-owned enterprises, which he says are “hugely inefficient” as they mostly operate in the manufacturing and industrial space, which is a troubled area of the market.
He says that by increasing its manufacturing base, China has been the driving force behind global deflation.
“We believe a hard landing is now inevitable – it’s just a matter of when,” Lewis warned.
“However we expect further stimulus measures to put off the day of reckoning – interest rate cuts, cuts in the RRR, extending the local government debt refinancing, and state intervention in both property and stock markets.”
