Central banks now pose as big a threat to capitalism as communism once did, according to Bruce Stout, manager of the Murray International Trust, who says these organisations no longer have any credibility in what they are trying to do. 
Stout said the decade-long experiment started by central banks across the world following the global financial crisis has distorted valuations to such an extent that investors now need to look further afield for ‘normal’ markets.
And he added that extraordinary levels of monetary support are continuing to have an impact on valuations, despite tentative moves to withdraw stimulus.
Stout (pictured), an economics graduate, said actions by the Bank of England, Federal Reserve and European Central Bank have created an environment “that we haven’t really seen before”.
“When you were studying economics, it was always assumed that the end of capitalism would’ve been caused by communism – that was the popular prognosis of the day,” he said.
“But the end of capitalism is every bit as likely to be caused by central banks because they have now got to a point where they have no credibility at all in what they’re trying to do and they’re not in control of the situation in terms of the way they would’ve been in past cycles.”
Short-term interest rates (Total, % per annum, Jan 2009-Jan 2019)
Source: OECD
Interest rates remain at low levels in developed economies around the world and the sole flagbearer for raising rates – the Federal Reserve – has been forced to suspend its own hiking programme recently.
Stout added: “Nobody is allowed to go bust, markets are not allowed to have any sustained periods of pain without some reaction from the central banks and, therefore, the chances of normalising rates – whatever normalisation is, and I have no idea – is getting slimmer and slimmer.”
“From a practical point of view, you’re working in an environment of very fragile growth, but more importantly you’ve got lots of zombie companies that are only alive because of low interest rates and the debt loans that would have put them out of business a long time ago,” said the Aberdeen Standard Investments manager.
“That means they are cutting prices and pricing at marginal cost to raise cash to pay bondholders and therefore distorting the markets they operate in.”
Stout, who was appointed manager of the £1.5bn Murray International trust in June 2004, said that companies are struggling to make significant margins and therefore giving their products and services away at cost price.
“If you want examples, it’s like that in the retail industry, it’s like that in the banking industry and many other manufacturing industries where you just can’t make the margins anymore,” the manager said. “It’s because the cycle is not allowed to clear like it used to in the past.”
As such, Stout said central banks have been making the situation worse, not better, with their approach to setting rates.
He noted that the Nasdaq fell by almost 25 per cent – in US dollar terms – between the end of August until Christmas as investors became fearful that the Federal Reserve would raise rates faster than initially anticipated, although these fears were allayed last month.
Performance of index over period
Source: FE Analytics
However, Stout said there is a growing belief among investors that – despite the extraordinary levels of support for markets over the past decade – many industries have not been fixed.
Belief in the cyclicality of markets has also broken down, having been absent for much of the post-crisis period, resulting in investors paying greater sums for lower earnings.
“In the US, the people that most accept higher prices for lower earnings are the companies themselves because they are the biggest buyers of stock by a long way,” he said.
“Stock buybacks have become a fundamental prop for the US market, but for ordinary investors looking to invest in companies, the effect of low interest rates and great walls of money going into the stock market mean they’re paying higher and higher prices for lower-quality earnings.”
He added: “We’re 10 years into a business cycle expansion, so under any other metric we’re getting pretty long in the tooth. It wouldn’t be abnormal to expect a slowdown in earnings.”
The manager noted that while growth is low and poor in the UK, Europe and Japan, the US has been “slightly out of kilter with the rest of the developed world” due to president Donald Trump’s tax cuts and fiscal incentives 18 months ago.
“But they’re all gone now,” he said. “So we may well see that the US starts to slow down in line with the rest of the developed world and it will be interesting to see what the reaction is in aggregate to lower earnings.
“At the moment, individual companies are punished when they come up short with earnings or trading statements, but the market as a whole isn’t.”
With the developed economies likely to continue suffering the effects of the ongoing monetary experiment of central banks, Stout said investors should turn to countries and businesses in countries where the economic environment is “familiar”.
“The economic environment is familiar in something like India or Indonesia or Mexico where you have a positive real interest rate – the interest rate is higher than the inflation rate – so you have better returns,” he said. “You have lots of monetary flexibility because nominal interest rates are high relative to funding rates, so you can cut.
“And you have – in that environment – financial services companies, banks or retailers or whatever that can make a margin because you have normal macroeconomic conditions and you don’t have zombie companies or high debt levels that are distorting market pricing.”
He concluded: “In general those businesses tend to be realistically priced for potential profits for the simple reason that they’ve been off the radar of large global fund managers because they have been concentrated in indexes like the [technology-focused] Nasdaq.”
Since June 2004, the five FE Crown-rated Murray International trust has made a total return of 459.85 per cent against a 281.3 per cent gain for the average IT Global Equity Income peer.
Performance of trust vs sector & benchmark under Stout
Source: FE Analytics
The trust is 11 per cent geared, is currently trading at a premium of 4 per cent to net asset value (NAV) and has a 4.3 per cent yield. It has ongoing charges of 0.64 per cent, according to data from the Association of Investment Companies (AIC).