Income Seekers Beware of False Recovery

Consensus views are wrong, says Newton's Nick Clay - developed market economies have not recovered and equities sensitive to growth will suffer once the truth outs

Emma Wall 25 July, 2014 | 12:25AM
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This article is part of Morningstar's Guide to Investing for Income




Emma Wall: Hello, and welcome to this Investing for Income Special. I'm Emma Wall and here with me today is Nick Clay, manager of the Newton Global Higher Income Fund.

Hello, Nick.

Nick Clay: Good Morning.

Wall: So, I know at Newton, you have an anticonsensus view of the market. The consensus view is, things are looking great, equities are positive, developed markets are recovering, emerging markets will recover. What's your view?

Clay: So, well, our view is that the economic experiment that we are in the middle of, which is quantitative easing, printing of money, and that printing of money which would drive up asset prices or therefore allow the economies to recover on the revitalisation of animal spirits. We believe that, that is not working. That is, all it is doing is, causing distortions in asset prices, distortions in economies, it is making certain parts of economies recover, but utterly dependent upon the drug of QE.

Therefore, now that we're in a process of trying to take that drug away, we're going to expose the fragility of economies that are out there, which is against the consensus view, which is that there are no the fragilities, that we've cured the patient. They're about to walk on their own two feet, and therefore you should invest accordingly, invest for growth, invest because there's no risk around, so take on risk in your portfolios and we believe the opposite is true.

We believe that the economic growth hope will disappoint, and therefore, you want to invest in companies, which are much more structural in the way that they look to generate their returns and you need to be very mindful of risk, there's still an awful lot of risk around. So, you need to be very careful of, not just the companies but the currencies and the countries within which you invest.

Wall: Not to champion the cause, but the data does seem to support the consensus view, taking out the sort of blip of the weather event in the first quarter of this year in the U.S. Things – recovery looks like it's in place, we are officially out of depression in the U.K. Why do you think this isn't true?

Clay: Okay. So, well, that was some blip – that blip in the first quarter minus 2.9 GDP growth revised down from plus 0.1, when they announced it. However, it's about what is driving the recovery in the numbers that we're seeing currently. If you look at what's behind it, a lot of it is utterly dependent upon zero interest rates and the ready availability of cheap capital, so is the housing market again, it's auto markets and zero financing on auto financing et cetera, and therefore, if it's utterly dependent upon the provision of the drug of zero interest rates, when you start to take that away, is that sustainable?

Can it continue to march forward without it? We would contend that it's not sustainable, and that it's really been artificially held up.

We are effectively trying to recreate growth in another bubble via debt again, and if we sort of – just sort of take a step back and remind ourselves what debt is, debt is simply taking tomorrow's spending and dragging it forward to today. And what we're tending to find is that in order to generate more spending today, we're having to drag ever more spending from tomorrow forward back to today and therefore eating in to future consumption.

You can see exponentially debt has been rising for ever little more increments of GDP every time we do that, and therefore, you start to take away the availability and the attractiveness of that debt, the zero interest rate, the zero funding, then very quickly the consumption starts to slow back down again, and we've seen evidence of that already happening in the U.S. for example, where they only talked about taking the drug away in the summer of last year and the housing market has so much slowed down in activity. Again, pointing to the lack of sustainability in this and therefore the fragility that still exists out there, which quite frankly everybody now feels has been removed.

Wall: With that in mind, how does that influence your investment decisions, where are you seeing good opportunity given that backdrop?

Clay: So, we are very much focused on companies, which are not dependent upon an economy recovery coming through, and so therefore, for want of a better definition we're in quite boring companies, structurally driven, they can help themselves rather than reliant upon a consumer to continue spending, a government to continue spending. They are companies which can generate their own internal cash flow.

They are not dependent upon access to cheap leverage in order to keep their business models moving forward, and they have margins, which we believe are sustainable. Margins generally across corporates at the moment are very elevated.

I mean, a lot of that again is to do with the distortions of the word in which we're in, which is helping keep corporate profit margins up high, that again is something we feel is unsustainable over the long-term, but in certain companies, which have a very strong, the buzz word at the moment is moat, have a very strong defence to their business, therefore can protect their margins against competition coming in.

Those are the kind of companies we want to focus on in the portfolio.

Wall: Nick, thank you very much.

Clay: Thank you very much.

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.

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Emma Wall  is former Senior International Editor for Morningstar