The Federal Reserve’s two-pronged process of ‘normalisation’ involving rate-hiking and quantitative tightening (QT) is causing problems in other markets, prompting Jupiter Asset Management’s Ariel Bezalel to become the most bearish he has been in 10 years.
Bezalel – an FE Alpha Manager and manager of the £3.8bn Jupiter Strategic Bond fund – said that market conditions have become much more difficult for fixed income investors, largely due to challenging macroeconomic conditions.
Indeed, Bezalel said the structural problems facing the global economy are “significantly worse” than they were during the global financial crisis of 2007/2008, with global debt of around $350-370trn.
Meanwhile, the Jupiter manager said there are demographic challenges across both developed and emerging markets that are “somewhat unfavourable” to economic activity.
As such, Bezalel said the team behind the Jupiter Strategic Bond fund has started to change its approach to investment.
While the manager has traditionally hunted in the higher yielding parts of the market, he has become more focused on US Treasuries as macroeconomic factors have taken a front seat in fixed income markets.
“It’s probably the most bearish we’ve been in the last decade,” he said. “While for the past decade I would say that the credit rating of the fund has hovered around BB, high BB or BBB [but] the average credit rating [for the fund] is now at A – really up the rating spectrum.
“The markets are very much moved by a macro. The reason is that over the past decade or so if you look at major central banks of the world – say the Fed, European Central Bank, Bank of England, Bank of Japan and People’s Bank of China – you’ve had $20trn worth of quantitative easing.”
Source: St Louis Fed
Indeed, while many investors and managers were more positive about markets heading into 2018, Bezalel said they had disregarded the withdrawal of liquidity from the system through quantitative tightening (QT).
“Many people at the beginning of 2018 were very excited about global economic activity, pumped-up about equity markets in Europe and talking about globally synchronous growth,” said the FE Alpha Manager.
“Our view was basically that it was globally synchronous ‘BS’. The central banks were now taking away the punch bowl that was basically firing up asset prices for the past decade or so.”
While the Federal Reserve has been hiking rates since the end of 2015, what changed this year – said Bezalel – was the introduction of QT which has sought to unwind a decade of quantitative easing following the global financial crisis.
“In February we had a shock to equity markets, all of a sudden there was a big jump in volatility and a number of ETFs [exchange-traded funds] invested in volatility went bust,” he explained.
“Then, as we progressed [through the year], we started to see problems in emerging markets, where we had the likes of Argentina and Turkey in the firing line.
“As the Fed continued to hike rates and [continue] its QT programme the problems became bigger and bigger.”
Starting in Latin America, the problems widened to other parts of the emerging markets before China, whereupon it is likely to branch out to developed markets.
“China’s economic activity has slowed down somewhat,” said the Jupiter manager, highlighting several months of slowing global manufacturing purchasing managers index figures – a key indicator of economic growth.
Source: IHS Markit
In October, the index fell to its lowest level in almost two years as growth in output and new orders weakened as Chinese growth stagnated. A reading below 50 suggests a contraction in the manufacturing sector.
Bezalel said the problems in China have also started to spread to Europe, traditionally seen as a safer market for fixed income investors.
“Even industrial powerhouses like Germany have started to become infected by the slowdown in China,” he said. “Emerging markets are hugely important because around 60 per cent of GDP and actually as much as 80 per cent of GDP growth.
“A lot of countries are reliant on China economic activity so as China slows down their demand for German and Swedish exports [for example] have really begun to roll over pretty sharply as well.”
One of the biggest problems facing China and other emerging markets is the strength of the US dollar, as the Fed’s aggressive rate-hiking policy and US fiscal stimulus are not helping matters.
“The dollar is a huge problem because over the last decade or so emerging markets have taken on trillions of dollars of debt,” said the manager.
“The Fed are saying ‘our currency is your problem’ and they are quite happily increasing rates. When you are doing QT you are selling Treasuries in to the market. Some of those [buyers] are using dollars to buy Treasuries and sucking dollars out of the system.
“At the same time, you have the American government giving the economy massive tax cuts and raising a massive deficit and to finance that you issue Treasuries and again people are using dollars [to buy them].”
He added: “It’s no wonder the head of the Central Bank of India wrote a letter pleading with the US to stop it because of the damage it was doing to a whole host of emerging market economies that had accumulated dollars.”
However, this could also have problems for the US market – which the manager said is in a “classic late cycle” position, noting that “almost every recession has been brought about by the Fed tightening rates until it damages growth”.
Bezalel said equity markets are beginning to exhibit signs of being a late cycle with firms becoming ever-more leveraged and stockpiling inventory as ‘trade war’ starts to bite into exports.
As such, the manager has taken a high conviction position in US Treasuries and taken risk off the table, given the potential downside risks to economic growth, unsustainable consumer growth and decelerating money supply.
Indeed, Bezalel has positioned for a more unpredictable environment for the next 12-18 months and “have preferred to be too early to position the fund cautiously, rather than too late”.
He said: “We think [10-year US Treasury] yields can’t go much higher than much above 3 per cent. Once they pop up much more than 3 per cent they seem to provoke a bout of volatility or crisis.
“We believe we are a year to a year-and-a-half away from recession, bear in mind the markets don’t wait for a recession they price it into liquidity ahead of time, typically 12-to-15 months ahead.”
Bezalel has overseen the Jupiter Strategic Bond fund since launch in June 2008 and aims to achieve a high income with the prospect of capital growth through investment across a broad range of bond markets.
“I’ve been running an unconstrained mandate now for the last decade or two,” he said. “It’s really about allocating to parts of the credit markets which we believe will perform best in certain parts of the economic cycle.”
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
Since launch, the fund has delivered a total return of 109.19 per cent compared with an 85.22 per cent gain for the IBOXX UK Sterling Non-Gilts All Maturities index and a 62.74 per cent for the average IA Sterling Strategic Bond member.
Jupiter Strategic Bond has an ongoing charges figure (OCF) of 0.73 per cent and a yield of 3.9 per cent.