AS we enter the fourth quarter of 2021, uncertainties abound such as the impending tapering of monetary policy by the US Federal Reserve, the persistence of inflation and the outlook for China investments. We speak to Norman Villamin, chief investment officer (Wealth Management) of Union Bancaire Privee.
In your reports you refer to a mini-cycle. Where are we in this mini-cycle and what are the implications for inflation and interest rates?
The way we characterise a mini-cycle - if you think over the past year, everyone got excited about the economic recovery. Growth was accelerating, people were getting jobs. The mini-cycle - we look at the ISM (manufacturing index) number. The ISM breached 60 and the Federal Reserve signalled a policy pivot over the summer.
You get worries about recession and growth. We're still at a fairly early stage in the broad cycle, and central banks begin to experiment a little. They step away to see how much the private sector can pick up the slack. When the private sector falters they step in once again.
If you recall in the 2009/2010 period we were all very afraid of inflation; central banks were printing lots of money. And inflation didn't materialise. We're now essentially in a position of a handoff from a recovery-oriented inflation. We're seeing pressures from shortages - like semiconductor chips. Those are probably the most high profile ones, and that will take a number of years to resolve. So there is some underlying inflation pressure.
But there are two pieces of the puzzle. One is wages. Most central banks are happy to see wages rise, because the underlying issue of inequality is an economic issue, and it's also a political issue. On most measures, wages are rising by 2 to 2.5 per cent, which isn't too troubling.
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We'll need to keep an eye on that. The other issue is the property market. When we look at it on a two-year basis, in the US the two-year compound annual growth is about 11 per cent per annum.
In Germany, it is about 13 per cent. If you're a central banker you'd be a little worried about that, in particular the US because the only time the number was higher was in 2005-06. And you could argue the Fed didn't rein that in enough.
I think the Fed could look at the property market and say, this could get a little messy. Let's slow things down a bit. When they started tapering in 2011, you saw property prices flatline at about 5 per cent per annum growth. I think that's where they're trying to go.
What does this all mean for investors? Are you risk-on or off?
We are risk-on. If you look historically at how these mini-cycles play out, it's clear that everyone makes money. When the mini-cycle begins, which is usually around the time when the central bank announces it is going to step back, we think it will be later this year, to the time when the central bank decides to ease up a little - point-to-point you end up making money.
As we transition into this mini-cycle phase, you do see 10 or 15 per cent corrections. Even so, point-to-point in the mini-cycle, you make money.
We prefer to stay engaged and reduce the risk on the exposure we're holding in the market right now. If the market falls say 10 per cent, we don't want to be holding things that are falling 20 or 30 per cent as we've seen in the past. This year you've made money because of earnings, not because PEs (price-earning multiples) are going up. In fact, PEs more often than not have gone down. We're trying to avoid high PE types of names where you get the PE compression. And so we've cleaned up the portfolio to pivot towards those thematics, rather than the more speculative names that were driving the market late last year and early this year.
You have moved to a neutral position on China. Why is this so and what is the longer term outlook?
Yes, we're neutral at the moment on China. This reflects a couple of shifts since the beginning of the year. We had thought China was going to accelerate some of its strategies which would play out favourably in the equity market.
Instead, they're really focusing on restructuring and reform, and laying a foundation to accelerate in the future. We've had exposure to Chinese government bonds, which we exited in the second quarter. And we reduced some Chinese credit exposure within the portfolio as well.
In terms of the ongoing regulatory shifts, what it means is that the largest Chinese corporates are going to have a role in social reform in the country going forward - greater wage and pension responsibilities, for example.
Companies are making very large donations to support social efforts in China. So we think this means that the overall profit profile for these companies in the longer term will start to change. They'll still be growing especially if they are in growing industries. But there is an amount they'll have to share with some of their broader constituents. This is very much an ESG kind of issue. It's not only making profits for shareholders, it's also looking after the community and employees.
We think that redistribution will be a headwind going forward. As an investor, you really want to focus on companies in the early stage of their growth cycle. That changes the way you invest in China. In the past few years essentially you read the five-year plan, look at who the industry leader is and who the CCP has tagged as the national champion. You basically buy that until they achieve their development objective.
Now we think the approach is less focused on looking for the industry leader, but looking towards some early stage segments and companies. Effectively if you're buying index-oriented products, you're going to be left with some of the mature, slower-growing names.
I'd like to get your views on the tech sector as well. It's the segment where there is intense interest in and concern about valuations.
I'm going to divide tech into a couple of segments. There is Big Tech, I can't talk specific names but we all know who they are in the US - big platforms, clean balance sheets. In absolute terms are they expensive? Yes, they are. If we look at the five Big Tech names - they are trading over 30 times earnings, which sounds like a lot.
If you go back to their individual IPO listings and put it all together, very rarely do they trade anywhere near 30 times.
When they do, they usually represent a pretty good opportunity for investors because they're growing their earnings very rapidly. This year a couple of names have done very well, and a couple of others moved sideways. But because they're growing their earnings 20, 30 or 40 per cent per annum, that means PEs are actually falling.
Then there is cyclical tech, like the chip makers. Because of the tightness we're seeing on the capacity side and the demand, we think the chip space is particularly attractive as well. Then, there are a number of more speculative names in tech - promising ideas, not yet making money, and negative free cash flow.
In an environment where you have low and negative real interest rates, and liquidity is plentiful, those names tend to do very well. As we get into this mini-cycle phase where liquidity starts to get pulled back, you'll have to be much more selective. And that's the approach we've taken - a much more selective approach on some of the more speculative names that have been performing very well in 2020 and early 2021.
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