InterestingLeigh – Mr Mcgee, don’t make me angry. You wouldn’t like me when I’m angry.
Leigh Himsworth, head of UK equities at City Financial & manager of the City Financial UK Select Opportunities Fund
For those of us old enough to remember those immortal words from the Incredible Hulk – the mild Dr David Banner, when pushed, used to grow, rip his shirts – never his underwear – go green, and go on the rampage – growth was not something to be relished!
Having had discussions with a number of ‘market professionals’ recently, all seem convinced that growth will be great news for us all. I disagree. For me, the key issue is the direction of monetary policy.
Since the beginning of 2009, after the huge drop in 2008, UK GDP has oscillated between -0.5% and +1.2% whereas the main UK Index has generated a total return of +87.3%.* In fact the market is near its all-time highs, not bad considering we have been in or are in the most significant global downturn for many years.
I realise that I am teaching many of you out there to ‘suck eggs’, but it is this closer relationship with interest rates that is crucial not to lose sight of – it is the process of recovery that can be very painful as longer term bond yields begin to rise. On a macro level the central bank has to mop up excess liquidity in the system by selling bonds, which clearly can be very poor for that market, and perhaps a variety of stimulus packages are withdrawn in a bid to reduce the absolute levels of government debt. On a micro level, companies that have been kept on life-support through the downturn and have managed to meet their fixed commitments due to low interest rates then struggle to meet this hike in their fixed cost base. It is true that more companies go bust at the beginning of a recovery due to this factor than in the downturn itself, as they are often unable to grow turnover due to some structural change that has hurt the underlying business.
Yes, I agree there will be many winners in the recovery, but these are already evident to a degree. Those that are well financed with cash to fund their growth plans, those with a strong niche, a new idea and so on. We are also at the point where, after an initial wobble, as a market we may well see a return to growth stocks. There is already strong evidence of this as the Small Cap index has out-paced the largest stocks by nearly 10% so far this year, a sign that investors are looking to increase risk in their portfolios as well as their exposure to growth. The market has moved through a range of phases, from safe equities, to value, to yield, and more recently momentum, to the point where I think growth should be next, though I thought we had reached this point some time ago.
In the near term, I am nervous, as the authorities in the US and UK have to communicate a clear plan to turn off monetary stimulus. We all saw the effect mis-placed words had in May; this must have terrified the central bankers.
A point that a colleague raised is why do it now? Remember that we are supposed to operate in a democracy - every measure relating to turning off the taps is a vote loser – raising interest rates, reducing fiscal stimulus, reining in job programs, cutting house buying programs and so on. Every measure to soften a downturn is the opposite. My hunch is that stimulus may well overstay its welcome – the ramifications of this could be scary in the longer term as inflation and debt levels may move beyond our control.
And very quickly, I turn to the point of using 7% unemployment rate as a trigger for turning off the taps. I read a very interesting piece by Shore Capital that, adjusting for immigration in recent years and the growth in the workforce, the true unemployment rate now was arguably closer to 6.5%. My point here is that there has been heated debate for years about the true rate of unemployment, on calculation methodology, true working population, migrant labour and so on. I was under the impression that tying interest rates to employment levels had died in the 1970s and that monetary policy should relate to inflation. For me, this tips the balance back to central banks becoming reactive again rather than proactive. As a highly regarded ex-colleague of mine, John Anderson, points out, ‘what happens if inflation surges up before unemployment falls?’
*Bloomberg – 31/12/2008 to 30/8/2013