- We talked to the international chief investment officer at JPMorgan’s $US460 billion bonds and commodities business about everything from populism to North Korea.
- He’s upbeat — unusually so for a bond manager — and said he favors local emerging market debt and corporate debt.
- He explained why markets are “desensitised” to North Korea, and why he’s worried about Australia.
Bond traders are the most reliable mongers of doom in finance. Danger sells their product. They’ll argue they can best protect your money – and even make some for you – in times of chaos, fear, and panic.
So it was perhaps a reflection of the unusual nature of what’s happening in the global economy that Nick Gartside, international chief investment officer at JP Morgan Asset Management’s $US460 billion fixed income business, had a thoroughly sunny take on the world when we met in London this month.
Looking around, points of worry are not hard to find. Voters are angry and disillusioned. Europe is fraying. Brexit is hugely uncertain. North Korea is testing missiles. There are vast levels of global debt, especially in China.
Then there’s the biggest worry of all: how economies and markets will deal with the huge shift in policy from the world’s central banks, as they move from years of ultra-low interest rates and money-printing to something resembling normality.
This has never happened before.
Amidst all this, what Gartside is most worried about – when perhaps you’d expect him to flee to anything safe – is that the global economy could prove to be even more muscular than anyone thinks.
“This will sound very odd, but what worries us is actually growth is a lot stronger,” Gartside said. “If you have that environment where growth is a lot stronger than anyone expects, then what happens is that central bank pricing will be a lot more realistic.”
Just take that in for a moment.
(Australia, he says, has “too much leverage” on the consumer sector; it’s one corner of the global economy that troubles him. More on that later.)
First, some context. Here’s an easy way to get to grips with the growing view among analysts that the global economy is gathering strength.
Take one favoured indicator of global economic activity — and bear with me — this chart, which shows the readings in “purchasing managers’ indices” from around the world over the past three years. In these surveys — produced at huge cost and involving thousands of interviews in each country with real business people — a reading above 50 indicates an acceleration in activity. The more above 50 you are, the faster the expansion. Now check this out:
That’s a lot of green. In both developed and emerging nations, from Asia to Europe to the US and to South America, industry is reporting high levels of expansion.
Gartside is currently counting the likelihood of a global recession around 5% over the next six to nine months. That means really big busts are unlikely for now, so it’s time to buy risk, in his view.
“You want to identify bonds which can benefit from that growth environment,” Gartside told Business Insider. “And two categories of bonds stand out. One is local emerging market bonds. Emerging markets tend to do well when there’s global growth. And there you go for your higher yielders, your riskier ones, your Brazils, your Mexicos, your Indonesias, South Africa, Turkey, Russia.
“The other area is corporate bonds, and within corporate bonds, high-yield. Your big risk with a high-yield bond is if you see a recession.”
With the global economy in good shape, Gartside says this is “a great environment for corporate bonds. And it means corporate yields can go lower”. If you’re holding those bonds, you may find less income, but they will appreciate in value as assets.
Now Aussies — and their pension funds — love stocks and risky assets. Pension funds around the world, broadly speaking, tend to have around 50% exposure to cash and bonds. Aussies tend to have around 35%, according to August data from Super Ratings.
This is a feature of Australia’s investing landscape that is a bit of a talking point in global finance.
Basically, compared to the rest of the world, Australians are exposed to a lot more risk when it comes to their retirement savings.
Gartside is currently counting the likelihood of a global recession at around 5% over the next six to nine months. That means the likelihood of big busts is low, so it’s time to buy risk, in his view.
Populism’s force is training the centre
He even has a positive take on the impact of populism in Europe, where in multiple countries there have been movements with radical economic agendas finding support from huge chunks of their respective electorates.
Although “populism as a theme in Europe is very much alive and well”, Gartside says, the political centre is adapting quickly.
Populist movements in Europe were “probably still a reaction to the crisis”, he said.
“If you think of the recent election in the UK, that was an election that said: ‘We’re fed up with austerity. It’s been 10 years, we’re fed up with not getting pay rises, and we want that to change.’
“So I think there’s probably a few responses to it. One is probably governments spend more. The idea of [spending] cuts is probably over. So you could see fiscal deficits expand a bit, and maybe they should. I mean deficits are not very big now.
“The other is that those more populist voices do have an influence. And again if you look at the way those centrist parties govern, they’ve altered the policies. You see that dramatically in somewhere like a Germany where they’re talking about a migration cap, and that’s a huge shift.
“So then oddly, that may strengthen the centre. The centre’s clearly broader but, if you see what I mean, [they’re] responding to some of those concerns.”
Why there’s no panic over North Korea
Nothing seems to be able to shake the confidence of markets lately, a dynamic reflected in the recent cover of The Economist’s cover which trumpeted “The bull market in everything”. The earnings outlook has been more positive in the US, employment is still gathering strength in major economies, and inflation remains benign.
Almost everyone agrees stock valuations are high, and yet US stock indices have continued to grind into record high territory seemingly by the day. This is despite North Korean dictator Kim Jong-Un and US President Donald Trump in an increasingly tense stand-off across the Pacific Ocean.
Markets aren’t rattled. Gartside offered his explanation.
“These are clearly high impact events, but seen as low probability events,” he said. “Also: how do you price that? It becomes very difficult, doesn’t it?
“I mean you could say, ‘I’ll assign a probability to it’ — but that’s making a big judgement — and then try to factor that into bond yields. I think that’s the reality. It becomes something that’s very, very difficult to price and model.”
He added: “I think markets get desensitised. So I think the very first time you get a headline in North Korea, you get a big reaction. By the time you’ve had the fifteenth headline on North Korea, markets are actually pretty dismissive of it. And I think we see a fair bit of that with all these different political events.”
China’s debt problem
Fitting with the broadly-everything’s-ok theme, he seemed sanguine on China. “I think the … interesting development with China is one of the ways they’ve smoothed that growth rate, is they’ve increased their budget deficit. Which is good, but at this stage in the cycle is not particularly what you’d expect.”
But wait. That means more debt! And China’s debt is now around 300% of GDP by some estimates, and there doesn’t seem to be any clear plan to reduce it.
“You look at the amount of Chinese debt and it’s very true to say, ‘In a year it will be a problem’,” Gartside said.
(He is right. People do say this every year.)
“The point is everyone says that at the start of every year…. you look at the amount of debt and leverage and absolutely it’s a big number, it’s realistic at some point that debt gets consolidated onto the government balance sheet.
“If you think what other developed countries did when they had too much debt, effectively they shifted that from the household sector, the corporate sector, onto the government balance sheet.”
Essentially the argument here is that Chinese authorities will be able to rescue their own broken and over-indebted corporate sector by doing what central banks did in Europe and the US: buying bonds in a relatively sophisticated way that signals to the market that the central bank is willing to back debt and keep everything under control.
“That’s another way of saying is China a developed or an emerging market? And it’s probably a bit of both in reality. Our sense is they will be able to do that, and manage that adjustment,” Gartside said.
A decade ago the big question was if the Fed could manage 15% unemployment and a banking system crisis in the world’s biggest economy. As the US has recovered, the world has a new economic force to reckon with in China.
His question about whether China is a “developed or an emerging market” is a profound one for businesses and policy-makers around the world. President Xi Jinping has consolidated his power now after the people’s congress this week, and so at least the world can expect an answer in the coming months on that absolutely critical question.
Australia — not keen
Gartside used to really like Australian government bonds. Not any more. “Australia and indeed New Zealand are markets we’ve liked from a global perspective, precisely because of the higher yields relative to other markets,” he said.
“As things stand now though, we’ve got very little exposure there. And our sense at least is that the RBA will move at least a couple more times in terms of hiking rates. And one of the things that takes the pain there is government yields. So you look at 10-year governments and they’ve been a good hedge. As you look forward, that’s less clear to us. Particularity given where inflation is.”
Given another inflation shocker this week, that view is likely to be reinforced.
The other problem is the consumer debt — huge mortgages — and the exposure to China.
“Consumer side… it looks as if there is too much leverage,” Gartside said but, continuing with his sunny theme, he said macro-prudential measures by regulators would help to manage the property market, and that Chinese policy control would solve many problems in the short-term as the world’s second-largest economy shifts from being driven by industry to being directed by consumers.
This means a problem for Australia, however. “Ultimately that will impact Australia in less demand for raw materials,” Gartside said.
It’s pretty clear from his comments that, despite all the opportunities in a previously fragile world, Gartside isn’t keen on having risk in Australia.
“Too much leverage” in households, and China’s transition meaning “less demand for raw materials” — it’s essentially a now well-worn story: Australians have built up too much household debt, and China can’t save the nation’s economy like it did in the run-up to the GFC and the period beyond.
The clients are being offered Brazil and Indonesia instead.