Back to School (please, please)

This week we consider some of the hottest investment questions of the moment and provide our updated views therein.?

Where’s the recession??

As we all know, interest rates have risen sharply in the last year or so at all maturities - the central bank tussle with pandemic and war-spurred inflation was expected to usher in recessions in much of the developed world. Even the reasonably dependable augers of gloom, the yield curve[1] and ISM manufacturing surveys, agreed. A recession was deemed necessary by some? to bring inflation back to heel in the US and elsewhere. So far, such economic downturns remain substantially absent. Europe is certainly slowing quite sharply, while the UK is still flatlining. The US, however, remains some distance from recession. Meanwhile the threat from inflation is ebbing everywhere you look. What gives??

There are many points to make here, but perhaps the most important surrounds strong views about the future and investing. There are never any certainties about what lies ahead. That is true whether times are turbulent or not. As a result, the activities of our short-term, tactical investing unit are confined to the edges of the overall funds and portfolios. Instead, we place greater emphasis on the role of longer-term, strategic asset allocation (SAA).

Plus ?a change??

Linked to this is the reminder that it is always subtly different every time. Comparisons with various segments of history can be useful in framing short-term trends. However, the tendency to look for precise playbooks in history is dangerous. There has simply never been a situation where a services- dominated developed world economy has been shut down, reopened and its various consumers flooded with government support. The leftovers from that pandemic-induced support, or excess savings, are likely part of the reason for the continuing resilience of many economies in the face of sharp interest rate rises.?

We should also caution that a recession may still come. The path from central bank decision to the actual wallets of consumers and businesses is long and winding, particularly in the US. The important point for us as investors is obviously not whether the US or others manage to avoid a recession. It is more centred on the interesting trends we are seeing in intellectual property and research, as well as development spend across the developed world. As last week’s In Focus touched on, there are signs that the AI craze is solidifying into something meaningful. That would be something to get really excited about.??

Cash (and short maturity bonds) or Investments??

Over time, we would expect the team’s collective investment efforts to comfortably beat the return available from cash and short maturity savings. But in the short term, it could be a bit more marginal. However, clients should bear in mind that the high interest rates currently on offer in many currencies are already incorporated into our SAA.?

This is the process whereby we evaluate the risk-reward trade off on a variety of asset classes, from cash and short maturity bonds to equities to commodities. This includes analysing how these very different asset classes interact with each other in different environments. We then apply the optimal mixes (of assets) to our range of multi-asset class products.?

Those higher interest rates are part of the reason why in many of our risk profiles the weighting to investments such as cash and short maturity bonds, has risen substantially. The point being that you should beware thinking separately about the offer of a high interest rate on a savings product, and an investment portfolio. They are all part of the opportunity set we are trying to exploit on your behalf. Treating them independently of one another risks double counting the efforts of our teams of asset allocation specialists.?

Is China having a Lehman’s moment (or Japan in the 1990s)??

The explanations for China’s current plight fall into two broad camps.?

One centres around something called authoritarian expropriation risk. This worries about the seemingly ever-increasing role of ideology in the economy. It risks blunting the incentives of risk takers in many important ways. Within this batch of worries, the incentive to innovate, to have wacky ideas and so on, is seen as indistinguishable from free speech and accompanying individual rights. History is certainly littered with cautionary tales of authoritarian states ultimately running into the ground. According to proponents of this view, the end game predicted by history is here.[2]?

The second batch focuses more directly on the property market but comes to a similar conclusion. In the space of a generation, China moved half a billion people from the countryside to multiplying cities. This process, as we’ve explored before, came with miraculous levels of poverty reduction. However, there was always an end, a moment when the country could urbanise no more. That moment approaches which means that dealing with the baggage associated with this rapid urbanisation can be postponed no further.?

However, we must remember that there really is no historical or other analogue for China today. Not Japan in the 1990s, not Lehman Brothers nor any other Minsky moment.[3] There has simply never been an economy of China’s scale, sectoral make up or institutional set up.?

There’s a warning here: There are all sorts of narrative and other traps to fall into - There is unease about China’s model of governance around the world. This can too easily translate into a search for reasons why it might fail economically. Keep in mind, that a mid-19th century British person might have made very similar arguments to the ones outlined above about the emerging US, right before it overtook the British as global hegemon and surged ahead.

The US had, or at least was perceived to have, an inferior education system, particularly higher education, and an inferior scientific establishment. It was labouring under crony capitalism epitomised by the robber barons.[4] Bitterly divided, unequal and governed by what was seen as an already creaky political system. There were also plenty of accusations of intellectual property (IP) theft, just as with China today. Essentially in the middle of the 19th century the US was perceived by many to be an IP-stealing laggard, capable only of mass production of basic goods… until it wasn’t.

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*This article is for information purposes only. It is not intended as a product offer or investment advice

[1] The yield curve and predicting recessions – Federal Reserve Bank of Chicago

[2] https://www.foreignaffairs.com/china/end-china-economic-miracle-beijing-washington

[3] https://en.wikipedia.org/wiki/Minsky_moment

[4] https://en.wikipedia.org/wiki/Robber_baron_(industrialist)

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