Fiscal cliff be damned: investments go on
Bob Browne, Chicago-based CIO at Northern Trust Global Investors, predicts that in a year from now we’ll all be talking about low interest rates, but that the US ‘fiscal cliff’ currently stalking market sentiment will hardly be remembered.
Not because American politicians will make a last-minute December deal to avoid austerity moves, but because long-term investors won’t be affected by it.
“Come January 1 [2013] it’s still going to be a mess in Washington,” Browne says. Over the next several years, the US government will cut spending and raise taxes.
The question is one of timing and abruptness; the fiscal cliff front-loads all of that activity. For an investor with a five-year outlook, the short-term economic impact will not lead to a meaningful difference on equity or fixed income returns.
Niall Quinn, London-based CEO of Boston fund house Eaton Vance’s international business, says the fiscal cliff does not sway his views on owning US government debt. “The fiscal cliff is irrelevant to US policy interest rates,” he says, noting that the US is behind Europe in implementing austerity and that such moves are inevitable.
Neither man wants to see the US fall over its self-imposed cliff, which if imposed would see $640 billion worth of tax hikes and spending cuts across non-entitlement items implemented immediately in the federal budget, unless the Republican Congress cuts a deal with president Barack Obama and the Democrat Senate before the end of December.
But they see a broadly positive trend in the US, which is grinding out household and public-sector deleveraging and enjoying a return to growth in the housing market.
They spoke yesterday at AsianInvestor’s latest conference in Singapore for institutional investors, distributors and family offices.
Quinn talked up the desirability of a macro approach to institutional portfolios. Eaton Vance prefers emerging-market currencies and equities. The US may be enjoying a gradual recovery, led by housing, cheap energy and a revived manufacturing story. But this is not translating into employment.
The situation in Europe is far worse, he says, while Eastern European sovereign bonds and Asian currencies such as the Singapore dollar and Korean won look relatively attractive.
Browne says that developed-country accommodative monetary policy will remain the dominant fact for “years to come”, which will support both bond and equity markets and push more investors into risk assets.
The ‘new normal’ of low growth and deleveraging may be true, but the monetary response makes capital markets a good bet, he says. There will be just enough inflation in the system to make cash and short-duration fixed income lose money for investors in real terms.
Over five years, Browne predicts that US equities will return an annualised 8.5%, and emerging-market equities will return 11.1%. The only part of fixed income he expects to provide a positive real return is US high yield. Gold should provide about a 6% return over five years, enough to serve as a diversifier should risk assets turn south.
What this means is that investors will face a major problem regarding liquidity. Given that cash is likely to return a mere 0.5% over five years (with US inflation expected to be around 2.3%), liquidity carries a punishing cost.
That means CIOs and treasurers must be more choosy about liquidity, and perhaps look instead to relatively liquid asset classes such as equities; long-duration fixed income is too volatile to serve as a liquidity provider, he says.
Within bondland, he would like to see more investors add triple-A rated corporate bonds to their ‘risk-free’ bucket because issuers such as ExxonMobile and Nestlé are now more trusted by markets (measured by CDS spreads) even than Norway.