What Threatens Your Investments?

MARKET REACTION: As the OECD downgrades its forecast for global growth, we look at the potential impact of the Ukraine, a Chinese banking crisis and inflation on markets

Emma Wall 7 May, 2014 | 8:33AM
Facebook Twitter LinkedIn

Emma Wall: Hello, and welcome to the Morningstar series, Market Reaction. I'm Emma Wall and here with me today is, Tony Lanning, manager of the JPMorgan Fusion Fund range.

Hello, Tony.

Tony Lanning: Hi.

Wall: So this morning, we've had the OECD downgrade its forecast of global growth this year from 3.6% to 3.4%. There are probably several reasons why they have made that decision, but there are some prevalent threats to the global economy at the moment; one of them being the Ukraine. I mean, how much of an impact does that have on investors?

Lanning: Well, I think – I think the starting point for me is that markets, stock markets, financial markets performed really, really well last year. So my starting point is if it hadn't been the Ukraine, I think it would have been something else. I think we see – whilst the tensions in Ukraine are tricky and they are particularly tricky for fund managers, because we don't really know how this is going to escalate. The consensus at the moment seems to be that it will be resolved, that the Russians have too much at stake for there not to be a resolution, a satisfactory resolution. But it's certainly creating some uncertainty, and as we know, stock markets don't like uncertainty.

But I think given the amount that stock markets had risen last year, what we're really seeing is I think is quite a healthy correction actually. And for us, our fundamental views on the world haven't really changed and at the margin, we've been using these sell-offs in markets as an opportunity to add a little bit of risk back into our funds.

Wall: Ukraine ticked off that. China has another sort of worry, that's been rumbling around in the background for some time. Some people are saying that actually these managed defaults are actually good for the Chinese market, and indeed for sort of global stock markets. Other people are saying that that banking crisis is still ripe to implode at any point, where do you sit on the matter?

Lanning: Yeah, I think China, more than any other market, there are very polar views on it actually. Stepping back a stage, I think that investors may be a little bit guilty of getting wedded to the idea that China would grow at 10% forever and that clearly wasn't going to be the case. As the economy matures, it is going to grow more slowly, and I think policy makers in China are going through that very difficult and delicate transition towards a kind of a more sustainable, better quality growth. So, the latest growth trend at 7.4%, that's growth we would die for frankly here in Europe.

I'm in the camp that says that China has so many opportunities for medium to long-term investors that I always want to have some exposure there. So again, China was a very difficult market last year. It was the Western stock markets that did very well, China and emerging markets less so. We actually made money out of China last year because we invested with a stock-picker who wasn’t in anyway bound by the Shanghai Composite Index. It was a very benchmark-unaware investment, investing in things like Macau gaming, and staying away from the large state-owned enterprises.

So, I still think there are opportunities. I think they are going through this challenging period of transition, but at this stage, I've got no reason to doubt that they will do good job of that eventually.

Wall: So Chinese stocks definitely still have a place in a well-balanced portfolio?

Lanning: I think so, and more broadly, as part of an emerging markets exposure. So as I mentioned, emerging markets haven't performed terribly well, but interestingly so far this year, they have. There's been a bit of mean reversion going on. Western markets did brilliantly last year. Eastern markets didn't do so well. We're seeing, I think, emerging markets are at a point now where, yes, they could go lower, they definitely could go lower. But valuations are very attractive. For a medium to long-term investor, I think, valuations are sufficiently attractive that now might not be a bad time to be just starting to buy a little bit more.

Wall: You've touched on them there, that is going to bring us quite neatly to developed markets, and more specifically the U.S. stock market. I mean, anyone with exposure last year made easy money, but that's actually come off a bit in the first quarter. In the first quarter of this year, U.S. bonds actually outperformed U.S. equities. Looking forward, is that the developed market to be in or should we be looking a little bit closer to home?

Lanning: Well, we were one of those investors that did very well out of the U.S. last year. It was our largest overweight position, and at the margin, we've been taking a little bit out and we've been investing some of that into Japan because of the setback and into Europe, but we've still got a very healthy exposure to U.S. equities.

The U.S. economy is doing really well, really well. I think we had the taper tantrums, people worrying about whether Yellen's stance might be a bit different from Bernanke's. I've always been of the view that when interest rates start to go up again, that's the sign of a healthy economy.

But a bit like China, the market needs to kind of transition to that. We saw in the bond markets last year, in the third quarter, we saw bonds getting hit very hard, as the market just again just transitioned to an environment where interest rates will go up at some point. We don't think interest rates are going up this year, and maybe even the U.K. is the first place where we see interest rates rises, but they probably won't be this year.

So it's all about earnings for us now in the developed markets. As we've mentioned already, stock markets have gone up a long way. Now earnings really need to support that, and I think as a result, we're much more interested in investing in stock pickers now rather than impassive investments. We do own some trackers, but we think now particularly in those markets that have run up a long way, you need to be in those stocks that aren't going to disappoint.

Wall: You've mentioned that you think rising interest rates is a sign of a flourishing economy, but then Yellen has indicated that actually she is going to keep interest rates low for this year, maybe even next year. I mean, how do you marry those two views?

Lanning: Yeah, it's difficult, isn’t it? Because the one thing that the market isn’t worrying about at the moment is inflation, but it seemed to me that when we embarked on this quantitative easing experiment that it would be very, very difficult for central bankers to turn off the taps at exactly the right time.

So we haven't really begun with any gusto to put any inflation protection in our portfolios, but there will come a time when we will need to do that. We still own some duration assets in the Fusion Funds. We don't disagree that interest rates are going up at some point, but we are looking to create very well diversified portfolios.

So we're on the way with duration, but we've still got some sovereign bonds. And I think when you see things like the tensions in Ukraine, or if growth does disappoint as you mentioned the OECD downgrade, then you'll be pleased that you've got some bonds in that environment.

Wall: Diversification is everything.

Lanning: Absolutely. For us – as multi-managers – it's everything.

Wall: Tony, thank you very much.

Lanning: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Emma Wall  is former Senior International Editor for Morningstar