Investing in the era of Trumpflation
Charlie Morris tells Merryn Somerset Webb what has and hasn’t changed for investors as a result of Donald Trump’s victory, and what to do about it.
Charlie Morris tells Merryn Somerset Webb what has and hasn't changed for investors as a result of Donald Trump's victory, and what to do about it.
Will the election of Donald Trump bring major change to the financial markets? When I sat down after the vote with Charlie Morris, MoneyWeek contributor and editor of the Fleet Street Letter, this seemed the obvious first question. His answer wasn't quite what I think most would have expected, given the hysteria around the result: not really.
All the things the media has been talking about since the election "actually began in January or February of this year", says Charlie. Take the end of the great bond bull market. Sure, bond prices have moved "very, very strongly indeed" since the election, but this has been a market on the edge of turning for years or at least since yields hit zero.
There was a major reversal in the US in 2013, it happened in the UK in the summer; it is happening in Germany to some extent; and "despite their best efforts", in Japan too. This is a "land of rising bond yields" and of rising inflation expectations as the age of globalisation comes to an end. "The game has changed and inflation expectations and bond yields are now firmly rising."
What about the stockmarket? There are definitely positives there, says Morris (positives you can already clearly see reflected in soaring stock prices). Lower corporation tax translates directly into profit. Bringing US rates down from 35% to 15% would be very competitive globally. But more interesting than that is Trump's promised infrastructure fund. Look at the stocks that rose most in the immediate aftermath of the result it was all about firms that make bricks, mine stuff, or provide transport.
Then there is biotechnology. Hillary Clinton talked about price caps on drugs. Donald Trump doesn't. That's good news for biotech and health care. There is also good news for financial stocks.
There's a chance they will see reduced regulation, but they insurance companies in particular actually make more money in a higher rate environment than in a lower rate environment. And the idea that you should be in banks was there long before Trump's election; "my thesis all year has been bond yields are going to rise, banks are the place to be because they're cheap and they also respond positively to a bad environment for bonds". Note, by the way, that "populism is always bad for bonds".
Why inflation will make a comeback
So the inflationary expectations driving all this come from the spending binge? Very much so, says Morris. Trump has promised to make America great again. That has to mean economic growth. In the short term at least that can't really mean real growth that would involve massive productivity improvements. We might get some of this coming through as yields rise.
Low interest rates have "protected companies that shouldn't have been protected" by keeping the cost of their debt very low. Look at the churn rate of businesses ie, the number of businesses being created and the number that have gone bankrupt. It is low relative to history and that feeds through to give us our low productivity numbers. Higher interest rates will give us some of the creative destruction we need to shift them up: right now "we're at the low of the creative destruction cycle".
Still, this isn't immediate, so for the moment at least Trump won't be thinking of real growth. Making America great again must mean nominal growth, for which you need inflation (which, of course, has the other benefit of reducing the real value of America's debt). Okay. So what does all this mean for how we should invest today? The key point, says Morris, is to see it in terms of Wall Street and Main Street.
"In 2009 people were very surprised when the economy was terrible on both sides of the Atlantic and yet the stockmarkets soared, and you could say that it was Wall Street that had a good deal when Main Street didn't have a good deal. Now what's happening is that whole idea has gone into reverse, good times for Main Street, bad times for Wall Street." That in turn means that a traditional balanced portfolio (one with, say, 40% bonds and 60% equities) "is going to come under real pressure over the next few years as adjustment takes place".
It's been a good portfolio to hold over the last 30-odd years as falling bond yields have meant that both parts have done well. But now that has changed you don't want the bond bit any more. Why hold UK ten-year gilts when they offer you a negative capital return of over 15% over the holding period? "You shouldn't want to do that."
What inflation means for stocks
But with the return of inflation you also need to worry a little about stocks. For all the potential for Trump's plans to boost the market, "history tell us that inflation kills the price-to-earnings (p/e) ratio the valuation of a stockmarket comes under pressure as inflation rises beyond 3%-4%. As Russell Napier always says, "beyond 4% the bull market is over!"
It will take a bit of time for that inflation to come through, but it means that we are "looking at de-rating in Western stockmarkets, particularly the ones full of the bond proxies the consumer staples, along with the defensive stocks that have produced steady yields and so done so well out of low yields".
So we sell those stocks? Not so simple, says Charlie. In many cases they are the "lesser of two evils". Take a company such as Coca-Cola which in Charlie Munger's eyes is the best company in the world on the basis that it basically sells well-marketed sugared water. "Would you rather own a British gilt yielding minus 1.7, or Coca-Cola over a ten-year period? The answer must be Coca-Cola." If stocks such as this get derated, "they're a screaming buy".
What about the UK market as a whole? It is hard to argue that there is value in the US at the moment. But here the market isn't expensive by historical standards, says Charlie. There's a reasonable sustainable 4% yield and while there isn't much growth behind that,"so what? It's a better deal than the bond market". There are also parts of the stockmarket life assurance, commodities "that are fantastic". You could also be very brave and look at airlines, they're cheap and the oil price isn't high.
Keep an eye on politics
Otherwise, investors need to think about politics. How about a country that has a bad political relationship with the US but may soon have a good one and that is in a fabulous position to take advantage of the up-cycle for commodities? Russia is a "very cheap market" on a cyclically adjusted p/e ratio of just over five times that could be re-rated. What's more, you can buy their biggest internet stock, VK.com, owned by Mail.Ru (London International: MAIL). "It dominates Russian-language social media, and you can buy it for $3.9bn market cap, whereas Facebook is $300bn for the English language." Obviously, the English-speaking market is much bigger, but being in a dominant position in a language is a good place to be.
Otherwise, look at Chile well governed with a high GDP per capita and the commodity exposure you want. Any regional markets to avoid? Perhaps China, says Charlie. It is unlikely to have a good relationship with Trump and the sliding renminbi is killing its foreign reserves "never a good sign for a macro investor". This moves us on to Charlie's actual portfolios. He offers his readers two options one lower risk and one higher risk. The former ("Soda") "attempts to do the job of holding bonds without holding any bonds".
The latter ("Whisky") holds stocks, but with a sound process that (hopefully) cuts the usual risks of being in the equity market. Both are well diversified and low turnover (the lower your turnover, the lower your costs and the higher your returns), but neither contain much in the way of bonds! The idea, says Charlie, is to protect and to grow his capital over time. What about getting rich quick? I ask. If that's your aim, says Charlie, the stockmarket isn't the place to be. Instead, buy a lottery ticket or start a business and prepare to take an awful lot more risk.
Fact file: Charlie Morris
Charlie Morris is the editor of the Fleet Street Letter. He is also the chief executive and founder of CCData, an analytics platform for blockchains, and the Head of Multi Asset at Newscape Capital Group.
Prior to April 2015, he spent 17 years at HSBC Global Asset Management as the Head of Absolute Return, managing a multi-asset fund range overseeing $3bn. He grew up in Hong Kong and Yorkshire and spent a year at Sandhurst before starting work in the City.