Do you see a way out of the trade war between the US and China?
Yes, a resolution to this trade war can be found, but it’s getting harder and harder as a result of the increasingly stronger language being used. The domestic costs to both sides have increased: when Donald Trump compromises, his political base will react and Democrats, who also support a strong stance against China, will use it to campaign against him. And in China, the rhetoric has also been ratcheted up, with local media talking about national pride being dented. Economic costs will likely have to be higher to drive them back to the negotiating table.
What do you think of Trump’s decision to ban US tech companies from doing business with Huawei?
This opens up a whole new front in the trade war, as it’s the first overt attack on China that doesn’t use tariffs as a weapon. China seems already to have used up almost all its tariff-raising ammunition but as it has outlined recently, China has a full arsenal of non-tariff, strategic countermeasures. If the US or China actually deploys these measures, this could be very negative for global growth.
What effects is the trade war having on economic growth in China?
If you look at current tariffs and those that Trump is threatening to impose, then we’re calculating a potential 1% drop in China’s gross domestic product. China will most probably roll out a stimulus package to mitigate the effects, including devaluing its currency. That said, we’re talking about growth slipping from 6.4% to 5.4%.
How will this affect global supply chains?
What a lot of people forget is that businesses that chose China for their operations did so because all the support services were there: finance, transport, raw materials and so on. If manufacturers were to shift from China to other countries, then these secondary services would go with them. This process takes quite a long time. So, in the near-term, the disruption and additional costs on companies will unsettle previously efficient global supply chains.
Which regions would benefit from this sort of shift?
South East Asia, Latin America and, to a certain extent, Eastern Europe. I think an increased number of regional models would spring up in place of a seamless global model. So the overall benefit would be negative, as costs would be higher, but as a trade-off the risks would be balanced out. However, as seen with the recent tariffs on Mexico, even a shift to a regional rather than global approach still has its risks.
All eyes are currently on the trade war, so what other risks are being overlooked?
US economic data is showing the same signs of weakening seen in other parts of the world now. If the US economy had been as strong as it was at the beginning of last year, then it might have been able to cope with the trade war. However, with a weaker foundation to begin the next round of the trade war, the risks to the US economy are higher than they were. The risk of a hard Brexit currently stands at 25% and that’s problematic; it is increasing the pressure on sterling and represents a risk to European stability. Another potential trouble spot I’m seeing is Iran. Trump’s sanctions and aggressive posture towards Iran could be devastating if it escalates further.
Have you adjusted your portfolios to the current situation?
Our current investment strategy is based on the global economy, which is slowing, but it’s not yet in trouble. The difference now is there are asymmetric risks: as long as everything is running smoothly, then we can generate stable returns. However, if these risks are realized, then investors could face significant downside. This is why, as early as April, we shifted to a more ‘asymmetric’ portfolio construction so that we can participate in the upside if the economic momentum rebounds but also protect against risks should they emerge.
What investment approaches are you taking to achieve this?
Convertible bonds are attractive, as they can benefit from market upturns while also offering protection, thanks to the nature of the bond market. We also recommend selected long/short equity strategies which mimic our preferred asymmetrical approach rather than traditional direction equity strategies.
What would you say to risk-averse investors as regards the coming year? Should they just hold on to their cash?
Cash is not a good investment strategy especially for euro or Swiss franc investors looking at negative yields on cash. For cautious investors in the near term, we hold Danish mortgage bonds. They yield is nearly 2% with AAA rating and similar tenors as ‘risk-free’ German Bunds.
And what about if they’re willing to add a bit more risk to the mix?
Then I’d recommend event-driven hedge funds. Their volatility and risk are a bit higher, but their return profile more than compensates for this pick-up in risk. These would be appropriate for investors seeking a high-yield type of return that isn’t related to the potential for any deterioration in corporate credit markets.
And where should someone with a long-term horizon invest their money?
Both the US and China will be supporting their economies with stimulus programmes in the medium term. We expect a portion of that stimulus will go to supporting the transformation of their respective economies. Long-term investors should look to this pullback as an opportunity to add exposure to some of these secular transformation opportunities. e see fintech as a key opportunity in this regard.
You say that proactive risk management has become important again. How does that apply in concrete terms?
We have implemented a capital-protected investment strategy on two occasions in the past year – once in August–September 2018 and once last April. To be honest we weren't expecting the sell-off that occurred in the fourth quarter. But in August and September of last year the risk–return profile was not attractive for us while protection against risks was relatively cheap, so we took that coverage. A similar market configuration emerged in April so we hedged again.
And then came the Trump tweets and the month of May...
Exactly, proactive risk management pays off. You have to keep monitoring the risk–return dynamics and regularly adapt your positions.
What does the Q1 results season portend for the rest of the year?
We have seen a stabilisation. In Europe, returns were particularly encouraging, which shows that activity is picking up in the region. That is not showing yet in earnings but if the Chinese and US economies can rebound in the third and fourth quarters, this will have a positive effect on Europe. If, on the other hand, stimulus efforts remain modest and neither country sees an economic rebound and/or the trade conflict intensifies, then Europe will be challenged in the second half of the year.
So you expect the trade dispute to have an effect even on assets that do not have any strong connections with China?
In recent weeks what we saw were losses on the stock market for almost all companies with direct links to China. What market players forget is that a protracted trade conflict will deter even companies that are not directly exposed to China from investing, which impedes growth. My concern is that such a sentiment will spread more broadly and eventually hurt more domestically focused companies in the US and Europe.
What is the Fed's role in this, and how important is it for economic growth in the US?
The Fed is very important. If growth in the US slows down any further or financial conditions tighten (limiting lending to companies), then the Fed will need to intervene by lowering rates. This is similar to the pause in its rate hiking cycle in early 2019 as it saw the first signs of slowdown in economies and stress building in markets.
Are other central banks following the Bank of Japan’s approach?
In Japan fiscal and monetary policy are coordinated. Public spending there is effectively financed by the central bank as it buys bonds as part of its QE scheme. It works in a similar way in China. In the US, on the other hand, coordination is only possible implicitly. As for Europe, given the absence of a central fiscal authority, the Japanese model wouldn’t work well on the continent.
What is your forex outlook?
We believe the dollar could go up some more as it’s a safe-haven investment. However, as headwinds to the pound fade and we get clarity on the post-Brexit environment, long-term opportunities may emerge in British pounds. We are no longer expecting the euro to rise against the franc, and so we have closed those positions recently.
Is the Swiss franc also going to remain a safe haven?
Definitely. But the Swiss National Bank is very proactive in trying to prevent a further rise in its currency, especially against the euro.
Gold is also normally a shelter for investors, but it has hardly moved recently.
In the last few years gold has had to contend with rising rates and a strengthening dollar, neither of which is a good omen for the yellow metal. Now that rates are on a downtrend again, that obstacle is out of the way, and so I see gold as a relatively inexpensive way of hedging a portfolio. In any case it is the best commodity in the current environment.
CIO Private Banking