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Citywire Investment Committee No.2

Updated: May 18, 2022

As I write this Donald Trump has just been declared president and I congratulate him on playing a blinder of a hand. Let’s hope he can now prove to be an effective governor as well as campaigner. On the other hand, his opponent Hillary Clinton has now snatched defeat from the jaws of victory on two occasions. Pollsters too have got it badly wrong twice in the space of five months. They will both be licking their wounds for some time to come.

"Rising inequality tends to be bad for growth and, more importantly, bad for social stability"

As I mentioned in my first Investment Committee article a few weeks ago, we at Seneca are long term investors. From an investment perspective, we consider the likes of the EU referendum and the US presidential election to be dangerous distractions rather than predictable events that one can position for. Indeed, while equity markets at first plummeted in response to the increasing likelihood of Trump’s win, they quickly recovered.

What about the longer term implications of the election result?

Trump promised Americans in rural and rust belt areas that he would as president improve their economic prospects. In other words, that he would reverse the rising income and wealth inequality that has been ongoing for many years.

This is not a bad thing. Rising inequality tends to be bad for growth and, more importantly, bad for social stability. Nipping it in the bud may have been something that the Washington establishment was incapable of doing. That said, the Republican Party is traditionally the party that favours high earners, so Trump is not likely to have an easy ride. There also appears to be some inconsistency between the promise to address lower income groups’ stagnant real wages with his comments about lowering corporate tax rates as well as income tax rates for all. After all, Trump did not get rich with a high tax regime.

As mentioned last time, I am still moderately positive about the prospects generally for equity markets. This is because I think the next global recession is still some way off – the current business cycle may be longer because the 2008/9 bust was greater – as well the fact that valuations, while not hugely compelling, are still ok.

As for our positioning within equities, our key tactical asset allocation positions (relative to our strategic asset allocation for a particular fund) are an underweight in the US and an overweight in Europe. Both these positions can be understood in relation to respective business cycles and market valuations.

The US business cycle is fairly well advanced and as a result, core inflation has been rising and now stands at 2.2%. This is above the Fed’s inflation target of 2%, and thus the case for further Fed tightening has been strengthened. Equity market valuations are also less compelling than they were five years ago, though are not stretched to the point that would imply an imminent bear market. No, the case for being underweight the US is about relative not absolute prospects.

In many respects our position in Europe mirrors that in the US. Where the US’s business cycle is well advanced, Europe’s is closer to the start than the end. The Eurozone’s unemployment rate peaked in 2013 and has since only fallen to 10%. As a result, core inflation is still low at 0.8% and thus monetary policy will remain very loose for some time to come. Further improvement in the region’s economy as unemployment continues to fall, loose monetary policy, and equity market valuations that are reasonable all bode well for European equities.

Elsewhere, we hold no safe haven bonds but are finding value in other parts of the fixed income spectrum, notably short duration high yield. Perceived default risk tends to much higher than actual default risk as you get within 1-2 years of maturity, thus presenting an investment opportunity. Furthermore, by being short duration, we are reducing interest rate risk. This we think is appropriate given current low or negative real long-term rates and the possibility of rising inflation.

Finally, a mention of what we call Specialist Assets. These are generally closed-end funds listed in London that specialise in areas such as property, infrastructure, asset leasing and direct lending. They can often have high yields in the 6-8% range, with income streams that are relatively stable as well as index linked. In terms of price behaviour, many of our Specialist Assets have exhibited lower volatility than and are lowly correlated with the broad equity market. They have also on the whole outperformed the equity market. In other words, they can significantly enhance what might otherwise be considered traditional balanced funds that comprise only equities and bonds, without being investments that are complex and thus hard to understand.

Published in Citywire

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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