Japan is Running Out of Options to Boost Growth, says JPMorgan

Japan's is into its second lost decade, have central bankers run out of policy tools? JPMorgan's Talib Sheikh says investors should be wary of further easing

Emma Wall 25 April, 2016 | 2:36PM
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Emma Wall: Hello and welcome to the Morningstar series 'Why Should I Invest With You. I'm Emma Wall and I'm joined today by Talib Sheikh, Manager of the JPMorgan Global Macro Opportunities Fund.

Hi, Talib.

Talib Sheikh: Hi there.

Wall: So, I know that you have a thematic investment process and there are eight themes which help govern your investment decisions. And you've recently added a new theme, haven't you to this investment process.

Sheikh: That's right. Those themes really are the core of how we build the portfolio. We try and break the world down into things which we think will drive price action for many months and many areas, and you're right, we just added a new theme to the portfolio. It's called Japan Beyond Abenomics and I think it's interesting be it starting to explore the idea about seven years since the end of the great financial crisis. Japan's into its second lost decade, have central bankers run out of policy tools? Are we reaching the end of the road?

We've seen central bankers around the world cut interest rates to zero, engage in long term asset purchases or engage in QE, a number of rounds of QE and more recently we've seen central bankers trying to take interest rates negative. And I think the thing that makes the theme interesting is that the market perception of that has been actually taken quite negatively. So, we've seen the market going from, really thinking that negative interest rates meant free money and that was positive for risk assets. We're actually seeing it work back the other way. And people are starting to debate what tools do they have left in Japan.

Could they engage in more QE? Well, 20-year JGBs yield 25 basis point if they go to zero, what difference will that make? Could they buy equities, maybe that's something which is still left on the table. But it's clear they are getting towards the end of that prescription. What does that mean? It means that the risk to the downside probably increasing from here and also for any investors it means that many of those low risk, go-to type of assets, government bonds, investment grade credit actually no longer have any yield in them.

People have to look more broadly and people have to build more diversified portfolio. So, I think it's interesting and I think it also applies much more broadly than just purely for Japan. We think of Japan almost as the testing ground for this idea.

Wall: Well, as you say Japan is the guinea pig really, but these are tools which we may well find ourselves needing in the West. You got Janet Yellen in the U.S. being very dovish about interest rate rises for this year, because the global macroeconomic outlook is muted for growth. So, where Japan goes, is there a case that we may follow?

Sheikh: I think so you've seen that in Europe. Clearly, Europe have got negative interest rates from the central bank. You've seen them desperately trying to get banks to lend and actually even in Europe as long as a bank makes some relatively – meets some relatively lackluster hurdles in terms of expanding its credit book they can actually receive negative interest rates from the ECB. It's one of the reasons, one of our other themes is European gradual growth recovery. It's one of the reasons why we think that many of those high-quality dividend yielding stocks across Europe actually look reasonably decent value from here.

But I think the key thing as you point out is the global growth is just not as strong as people have expected, where seven years since the great financial crisis and we're really not seeing that exit trajectory or that acceleration in a way that we've seen historically. And I think some of that is still to play through. I think it means that asset prices certainly within risk assets are likely to be more muted going forward. It means the hunt for yield probably continues and probably broadens.

And also it means that diversification in portfolios is probably harder to find. The risks that you have to take in order to harness those yields is probably a little bit harder and having to work harder to deliver portfolio that’s well-diversified, I think, just becomes more problematic because of the structural world that we find ourselves in.

Wall: So in short, investors just accept at this point in the cycle, it's going to be slow growth, low growth, not just for the economy, but for asset classes as well?

Sheikh: I think so. I think we have seen risk adjusted returns of long-only assets degrade quite quickly really over the last year or so. In many ways, we saw that happened in August of 2015, when we saw bonds lose money, fixed income lose money, and credit lose money. I think those kind of episodes are likely to be more frequent.

Certainly, when we look at valuations across most developed markets, we wouldn’t argue that equities are massively overvalued here, but equally we are struggling to find lots of value. So return is likely to be a bit more muted. The risk adjusted returns are likely to be less; and the correlations between asset class is likely to become more unstable. So having a portfolio that’s appropriately diversified, I think is going to become even more critical going forward.

Wall: Talib, thank you very much.

Sheikh: Thank you.

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

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Emma Wall  is former Senior International Editor for Morningstar