In this Q&A, Sir Michael Hintze, Chief Executive and Senior Investment Officer of CQS, presents an update on the risks and opportunities he sees in markets in 20l5 and beyond.
Q&A with Sir Michael Hintze
Q: How do you see the investment environment for 2015 and beyond?
Sir Michael Hintze: I am constructive for markets over the medium-term. I continue to believe that while a US rate rise is a certainty, that rates in Europe and Asia will remain low, central banks will be accommodative and that liquidity will be supportive of markets. As always, there are many crosscurrents globally and there will be increased headline risk and volatility. Importantly, a combination of regulation and central bank intervention has led to market distortions that I believe are driving long-term secular and structural investment opportunities for our investors.
As we go to print, both Greece and China continue to capture the markets’ focus. It is difficult to know what the outcome for Greece and the Eurozone will be: it is firmly in the political arena and we are in uncharted waters. What is clear about Greece is that profligate fiscal behavior has consequences. Whether we eventually have a ‘Grexit’ or continue to kick the can down the road, there will continue to be headline risk.
The direct exposure of European banking institutions to Greece is modest. As can be seen in Figure 1, aside from Greek banks, direct exposures and the potential impact on Tangible Book Values are modest. Furthermore, in the event of Grexit one might also expect the ECB to inject substantial liquidity into the system in the event of adverse developments.
Turning to China, it has grown its economic miracle funded in part by debt. Indebtedness can lead to excesses and volatility, and potentially ties the hands of a central government in the long-term. There are market concerns either related to a bubble or correction, but what is clear to me is that there is a slow down in the long-term secular growth rate. I had been expecting GDP growth to slow to below 7% and perhaps as low as 5%. I had also expected US GDP growth to take up the slack from a global economic perspective. I had neither anticipated the extent of the rally in Chinese markets nor the rapidity of their decline.
The key thing is to understand the potential for contagion into the broader financial markets. Both Greece and China are serious matters which. in extremis, are clearly tail-risk events. We are monitoring developments carefully. I also continue to be mindful of an array of geopolitical fracture points that have the potential for transmission into the global financial system.
Q: How do you see the global economy performing?
Sir Michael Hintze: In terms of the economy, global GDP appears to be heading for 2.6% growth in 2015 and 3.3% in 2016. US growth is forecast to pick up from 2% in 2015 to 2.5% in 2016 and growth in the EU from 1.7% to 2.4%. I find it interesting that the economies in Portugal, Spain and Ireland are seeing vigorous rebounds, and Germany and the UK continue to be positive. AsiaPac is forecast to see growth of 4.7% and 5.1% in 2015 and 2016, respectively, Japan is forecast to grow 1% and 1.5% in 2015 and 2016 nevertheless the slow down in China could result in more modest rate for Asia Pac as a whole.
Q: Are you concerned about inflation?
Sir Michael Hintze: While some commentators argue that there is a growing risk of wage-push inflation in the US, I believe there are structural changes to energy supplies and in the work place that mean inflation may well be muted in the medium-term.
One should not confuse productivity and price deflation. While the US and UK labor markets are tightening, unemployment rates in large parts of the EU remain high. Figure 2 shows that while wages and salaries are rising, average hourly earnings remain muted.
Importantly, labor productivity growth in most developed economies has been low. In the US, labor productivity has grown by just 1.5%2. From what I can see, it is a puzzle to central banks. I believe that this is due to the growing proportion of the services’ sector share of GDP as illustrated by Figure 3. My sense is that it is difficult to measure the productivity of some of the most dynamic parts of our economy, such as social media. How can we fully capture the economic activity associated with apps and with Facebook? This is also true of robotics, artificial intelligence and biotechnology; Moore’s Law is at work.
Q: …And in the natural resources and commodities markets?
Sir Michael Hintze: I will not dwell on energy, given our recent CQS Strategy Perspective ‘Is this the End of OPEC’ in which we laid out our views on why the oil price is likely to remain in a range of US$30 to $60 per barrel. Another important factor is the Iran/US deal. One of the main sources of oil supply is Iran. I would suggest that a deal could be a quid pro quo for allowing Iran’s Revolutionary Guard to lead the front against Islamic State. It may not only be on nuclear, but also enable Iran to export its oil. Consequently, I believe there will be more downward pressure on the oil price and there is more downside risk to Brent than WTI. Overall, the consequence will be a massive change to the energy value chain including in the energy-related credit and equity sectors. As it relates to resources more broadly, my view remains that the slowdown in China’s growth rate will continue to challenge pricing of industrial commodities.
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