The second Old Mutual Global Investors investment conference in Latin America began in mid-May. On the 12th and 13th of May, Chris Stapleton, Head of Distribution in Americas, Andrés Munho, Head of Sales in Latin America, Florida and Texas, and Santiago Sacias, Regional Manager in Southern Cone, met with more than 60 investment professionals from Uruguay, Argentina, Chile, Colombia and Peru, in Punta del Este under the banner “Global thinking, Local understanding”.
Following an overview of the capabilities and strategy of the British fund management company, a discussion panel among the five fund managers attending the event, was moderated by renowned Uruguayan economist Michele Santo. Major themes for the evening were China, the stimulus policies of the European Central Bank, market sentiment and its divorce from fundamentals and political risks which threaten markets with the arrival of Bréxit, as well as the presidential elections in the United States.
The first round of questions began with concerns about the continued low oil prices and a weaker dollar, and how these two factors could have affected the Chinese economy. Josh Crabb, Head of Asian Equities and Principal Portfolio Manager at Old Mutual Pacific Equity and Old Mutual Asian Equity Income, commented that the fact that oil prices remain low is positive for Asia: “The fact that oil prices have stabilized at these levels is also important because investors use the price per barrel as a measure of risk. As per the US dollar, whatever happens with the path of rates in the normalization process, I believe this is already taken its toll in the market and that investors have adjusted for that. If you go to Indonesia and India, you can pick up the best part of 10 cents bond yield around the world, as pretty impressive as it is in Brazil, and I think, once you start seen currency stability, people are going to start chasing those yield down again”.
Ian Ormiston, fund manager at Old Mutual European Smaller Companies (Ex UK), added his insight into the behavior of oil following interviews with the management teams of oil service companies: “Because we have a very deep deflation in the cost curves, decisions have been deferred. One of the companies with whom we met last week is very confident that they will see a sudden recovery in the projects, but at the same time they are telling their clients that they may get the same project next year 20 % cheaper. So as I putted to the company’s CEO, ‘if you can get it a 20% cheaper, why not do that?’ to what I really received no response.” Ian is confident that the industry related to shale oil will recover if the oil price continues to strengthen; and he believes it is conventional crude oil which will face more challenges, once it reaches a threshold where there is a risk of delay in project margins.
What is the outlook for the Chinese economy?
On returning to the China issue, as a major player in the global economy, Josh Crabb revealed the two factors which in his opinion are most relevant in order to understand what is happening in the Asian giant’s economy: “Ironically, not as much is happening in China as people think. I think the reality is everything happens at a much slower path that people gives a credit for. From my perspective, there are a couple issues to consider: the first is the currency, let’s put what actually happened into context, we had a currency that was pegged to the dollar. Chinese authorities announced that, going forward, the Renmimbi would be linked to a basket of currencies, but did not really specify what currencies would make up this new basket, the only two options were the yen and the euro, both of those currencies depreciated suddenly, authorities made a one-time adjustment, and the whole world panicked.” Josh is confident that from now on, greater communication by the Chinese government will provide more clarity and intra-day variations, so this problem will disappear with time, now that the levels of speculation in the yen and the euro have drop off.
Josh Crabb’s second concern is the real economy and the excess credit perceived by a large part of the market’s participants: “Many people believe that the Chinese economy is back to a debt driven disaster because they are only looking at the credit data, but considering how credit works in China, where banks receive a quota on how much lending they can do over the course of a year, if they can lend at the beginning of the year or at the end of the year at the same interest for the whole year, the more likely is that they are going to try to lend at the beginning of the year, and as a result there is seasonality at the beginning of the year, and then comes back off again “. In relation to where the government’s stimulus measures are being directed, Josh insists that it’s not being spent on building ghost cities or bridges that lead to nowhere, but on real projects: “The stimulus is being directed at things as simple as metro systems, and the question that arises is, ‘how many metro systems can be built?’ That is because people do not appreciate that there are 190 cities with a population of over one million people in China, which involves the construction of 190 metro systems, a very significant figure”.
Another factor that is changing Chinese society is concern about pollution, five years ago nobody cared, they are now more aware about the high levels of pollution and require large investment amounts.
The subject of the conversation then changes, beginning a discussion regarding the return of high levels of volatility to markets, Justin Wells, Investments Director on the Global Equities team, who is involved in the management of the fund Global Equity Absolute Return (GEAR), a Market Neutral strategy that is the one flagship funds of Old Mutual, among other strategies,commented: “One of the areas which is more difficult to understand when assessing the environment in which we invest, is the fact that North America has seen the highest levels of volatility according to our indicators; and the greatest deal of pessimistic sentiment, a fact which is contrary to the economic growth embedded in that great nation, in that great economy. There are a lot of strange things happening in the markets today.” For Justin, this volatility has returned to stay for a while, but the positive side is that it can create opportunities for the active investor, which is the approach that his team is taking for the forthcoming months ahead.
ECB’s Purchasing Program
As for the effectiveness of the latest measures announced by Mario Dragui, Bastian Wagner, the fund manager who, along with Christine Johnson, makes the investments decisions on the structure of the Old Mutual Monthly High Yield Bond, expresses his opinion on the market reaction to the European Central Bank’s purchases program, which includes the purchase of corporate bonds: “I think the market was quite surprised by the magnitude of purchases announced with the new measures. When you think about it, the most challenging part will be to buy between 3 and 5 additional trillion on top of established government bonds purchases every month. They explicitly expressed that they wanted to buy investment grade debt denominated in Euros and up to 70%, which represents a large amount when taking into consideration that 5 billion Euros represent almost 2% of the all eligible market.”
Bastian refers to the generalized narrowing of spreads in the investment grade bond markets, but mentions that the effect on speculative grade bonds will be greater. He also points out several issues that have yet to be answered, such as what the effect of a new rate cut may be on the real economy, and what would happen if any of the bonds purchased by the European Central Bank loses its investment grade.
Meanwhile, Huw Davies, co-manager for the Old Mutual Absolute Return Government Bond fund said to be quite impressed with the ECB’s performance: “We believe that the program of the European Central Bank is aggressive and most likely to work. We have already seen some of these effects in falling unemployment rates, which really were at very high levels”.
Complementing previous opinions, Ian Ormiston pointed out that it is important to mention that, for the first time, the Central Bank recognizes that there is a problem in the European banking system, particularly within the Eurozone: “The negative interest rates are compressing spreads and are causing issues for the banks. It’s good that it is good that they now are talking about it, because the debilitation of bank credit is probably the biggest problem in Europe”.
Investor sentiment and divorce from the fundamentals
When asking Ian about the sentiment of the management teams of the companies in which he invests, the divorce between investor sentiment and fundamentals rapidly arises: “It’s amazing the way it is evolving. Especially, when comparing the first quarter reports to the end of year reports three months earlier, a time when CEOs were not providing guidance or giving very cautious guidance. Then the market fell, influencing the opinion of those who thought that Europe was heading back into a recession.”
Ian Ormiston mentions the case of the French economy as a symptomatic case of the entire European economy. In which most investors talk about France as a country which will never grow, and for which bad sentiment is developing due to the lack of proposals for economic reforms by the French government: “Just when everyone had given up on France, its economy begins to grow, fantastically, but not dynamically. Many equities basically reflected no growth at all; but growth is starting to come back. In France, one of the biggest impediments for growth are the labor laws which have really affected large companies. While small companies can more easily hire and fire, they can also help large companies by providing them with employees who are not necessarily included in their payroll.”
Meanwhile, Bastian Wagner compares the differences between the European and US markets, amongst which there is a curious divergence. While during the past four years the United States has seen significant activity in projects of M&A (mergers and acquisitions) and private equity; in Europe, this activity has either decreased or remained flat. “In Europe, we have not seen many private equity firms entering the market, making purchases, or with big M&A operations, which is a sign of lack of confidence. Which raises the question of whether the ECB’s measures are sufficient for the company directors to sit and decide whether an investment project should be executed, or whether maybe we need to go a step further, and the government should provide confidence to the private sector.”
But this lack of confidence doesn’t only occur in developed markets, Josh Crabb comments that sentiment towards emerging markets has been quite pessimistic for a long period of time, so that current valuation levels are very low. “Current levels are as low as they can be in a world without crisis. So, in that respect, they are quite negative, but the interesting part comes when we consider the positioning in stock. During the last six months we have seen that commodities stocks rallied a 100% to 200%, we have seen markets like Brazil which, with the wonderful news of the ‘impeachment’, rallied 50% in the course of three weeks. And most investors have missed it, which is a clear indicator of how extreme the sentiment is, therefore, a simple little event which makes the current situation somewhat less bad, can really change the market.”
Crabb also adds that perhaps it’s time for fiscal policies to begin to step in. In his opinion, fiscal policy tends to benefit emerging countries and obtains better results for the majority of the population by redistributing wealth.
As for the political risks facing the markets, Huw Davies believes that it’s unlikely that the UK exits the European Economic Community. For the fund manager, much of the risk of that event has manifested in the currency, the sterling pound. As the date of the consultation approaches, the strategy in which he participates will be distancing their exposure to the event, as it is an event of a binary nature. As for the US presidential elections, he admits to not having a sure bet: “Six months ago nobody imagined that Trump would get the Republican nomination, currently everything looks possible.”
Finally, Justin Wells refers to the role that these events are playing in terms of market sentiment. “All regions where we have positions are in pessimistic sentiment territory, the higher levels of political risk are the key driver behind that.”
