This article first appeared in Capital, The Edge Malaysia Weekly on December 9, 2019 - December 15, 2019

THE risk of a global recession is fading somewhat, despite continued challenges to the economy, says UK-based fund manager Schroders.

“We feel the risk of that is fading somewhat, and that is really because of the better data that we have been seeing in the US and signs of some resolution with the US-China trade talks [with a ‘Phase 1’ deal potentially to be signed]. The potential that has been associated with those trade talks has been a big drag on activity, because businesses are held back. So, I think that has been reduced, and also lower interest rates is something that helps to reduce that,” its chief economist and strategist Keith Wade tells The Edge in an interview.

Going forward, Wade says one should expect “lower for longer” when it comes to interest rates. He believes the US Federal Reserve may well ease rates again,“either once or twice”,  next year, with the initial cut likely to happen in the first part of the year.

As for whether another global financial crisis may be in the offing, that would be more difficult to predict, he said on the sidelines of the recently-concluded Schroders International Media Conference 2019 in London where key speakers from the company, including Wade, presented their views on the global economy and markets.

“It is always very difficult to know because it depends on whether investors decide that they are going to pull funding from a different area. As it stands at the moment, investors are still struggling with the fact that interest rates are very, very low and they have to deploy the money to make returns for their clients. And, you know, we are not seeing the kind of excesses seen in markets before that would herald a financial crisis.

“Certainly, people worry a lot about the leveraged loan market in parts of the US corporate credit market but, even there, when you look at some of the ratios, like the interest cover ratio that companies have, they are reasonably comfortable ... they are not overstretched and not in a situation where they will suddenly have to make big changes and cutbacks,” he said.

While markets are generally still very liquid, he said there have been some areas with problems for “particular, specific idiosyncratic” reasons. “ What we are seeing is that there are some pockets of the markets where investors have gone into areas that are quite illiquid and they have got burned as a result. This is because if there is a sudden change of sentiment and they do decide to sell, it is very difficult to sell. For example, there were problems in the property market when the UK voted for Brexit and some of the funds had to be what you call ‘gated’ — not our funds, though. But that was a problem because people just could not get their money out. So, those are some of the kinds of problems we are seeing.”

Schroders’ global head of investment Charles Prideaux said expectations of subdued global economic growth and low inflation — against a backdrop of disruption from populist policies, technology and climate change — remain “inescapable investment truths” for the decade ahead.

“Bluntly, we are moving into an environment where getting the micro right, as opposed to the broad macro, is becoming more and more important,” he said in his presentation.

Given this expected scenario, he said stock market returns over the next 10 years will likely be limited.

“With the exception of emerging markets, all regions are expected to deliver lower returns,” he said (see chart). Global bond returns will also be limited, he added.

Emerging market returns better

However, this does not mean that investors should shy away from stock markets.

“If you are going to be in the emerging market space, be active ... that’s how you are going to make your money. There are 26 markets in which you can invest. It is a very diverse place and you get different economies at different points of their economic cycle and very different market drivers,” said Tom Wilson, Schroders’ head of emerging market equities.

He said valuations are still quite reasonable in the emerging market space. “They are more expensive in the quality-growth part of the market than they are in the value part of it. But, even in quality-growth, they are okay. The issue, really, is that the EPS [earnings per share] outlook remains relatively uncertain [given] the relatively uncertain economic environment.”

For some time now, Schroders’ funds have been positioned towards the “quality growth” part of the market but, in the last few months, have begun to take some profit and shift a little towards the “value” part of the market, he said.

South Korea is a classic example of a market that could perform relatively well, he said, especially if the scope of the expected partial trade agreement between the US and China is bigger than expected.

Last Wednesday, US President Donald Trump told reporters at a meeting of Nato leaders in London that trade talks with China were going “very well” — a turnaround from the previous day when he said a trade deal may have to wait until after the 2020 US presidential election.

Bloomberg also reported that day that a trade deal between the two countries is inching closer and set to be completed before tariffs rise on Dec 15. Citing unnamed people familiar with the matter, it said the two sides are close to agreeing on the amount of tariffs to be rolled back in the Phase 1 deal.

At its recent strategy meeting, Schroders lifted its weighting on South Korea, said Wilson. It has also put some money into Taiwan in the last couple of months.

“[South] Korea is a very open trade-orientated economy and it has got a lot of companies that are really very cheap. It is quite a cyclically-orientated market. As for Taiwan, to a certain extent, the textiles [sector] has already outperformed relatively well, but again, I think maybe they will continue to perform if the scope of the Phase 1 deal [between the US and China] comes through wider than people expect and there is more of a de-escalation in [trade tensions],” he said.

Schroders is, however, “underweight” in Asia. “We have a preference for Latin America, which is a function of quite a material ‘overweight’ on Brazil. And, we are ‘overweight’ EMEA [Europe, the Middle East and Africa],” Wilson said.

Within Asia, its main “overweight” is South Korea, while it is “neutral” on Taiwan and China, and “underweight” on India, Malaysia and the Philippines.

Wilson said there are two things that could be helpful for Asian equities. “First, if the US dollar starts to depreciate more or faster than our current expectation, that is if it is not resilient, and assuming it does so in a relatively benign economic environment, that is really quite positive from an emerging markets standpoint. And secondly, if there is de-escalation in US-China trade tensions.”

Wilson explained in an interview that Schroders is “underweight” in Malaysia mainly because of valuations. “It’s really valuation more than anything else. The valuations have got better relative to history, but we have a quant model in effect, and the quant model guides are contra-allocation.”

The 1Malaysia Development Bhd scandal was not a factor for Schroders’ investment stance. “No, not really. It is really a function of what is the government doing from a fiscal standpoint and so on. But, in a nutshell, we are ‘underweight’ on Malaysia [based on our] quant model ... and we do not find a bottom-up driver to override the model recommendation either, therefore, we remain out of the market at this point in time,” said Wilson.
 

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