‘This country can’t be knocked out with one punch. We get right back up again and when we do, the world’s gonna hear the roar of our engines. Yeah, it’s half time America – and our second half is about to begin’
These were the words spoken by Clint Eastwood in an advert aired at half time during the recent NFL Superbowl, in front of one of the world’s largest ever TV audiences. The ad focused on Detroit’s car industry and used the manufacturing renaissance in ‘Motor-city’ as a symbol of the growing recovery across the US economy as a whole. The message was one of hope and a sign of better things to come.
So far this year, financial markets have also adopted this mantra, performing strongly during the early weeks of 2012. Positive news flow around manufacturing, housing and employment has created expectations economic momentum in the US is building. Global asset prices have responded positively to this and, just as importantly, to the European Central Bank’s (ECB) longer-term refinancing operations (LTRO) announced 9 December, 2011. There has been a marked shift in sentiment that this has taken the pressure off the wider European banking system and considerably eased the pace of deleveraging threatening Europe and the wider world.
Keeping with the action of central banks, the US Federal Reserve has announced the continuation of a low interest rate policy which will likely remain in place until unemployment figures significantly improve. The Bank of England has just advised it will be extending its QE programme by another £50bn, taking the total ‘spend’ to £325bn. Financial markets are clearly enjoying the "warm bath of liquidity" created by central banks. To help calibrate this, since the advent of the global financial crisis, the world’s four largest central banks – The Fed, the ECB, the Bank of England and the Bank of Japan – have printed sufficient cash to own 23% of the world’s assets.*
In terms of the current positioning of our portfolios at Affinity, we believe the optimism which currently abounds is, in part, justified, but are mindful of the headwinds which may lie ahead. The next round of LTRO takes place 29 February and some commentators have speculated the ECB may hand out as much as €1-1.5 trillion. Mario Draghi, the ECB’s president, has encouraged euro area banks to tap into this by stating ‘the facilities are there to be used. There is no stigma whatsoever on these facilities’ The size of this LTRO will be an ‘open kimono’ moment, revealing the extent to which the region’s banks are dependant on central bank funding for the next 3 years. Those banks making most use of this ‘free’ money will have the spotlight on them and the pressure to put their balance sheets in order will impact the growth prospects of their domestic economies and the performance of individual bank debt securities. This is something we are keeping an eye on.
Returning to the US, it is worth recalling that growth is sub-par and remains vulnerable to external negative shocks, such as instability in the Middle East leading to a rising oil price. Our assessment, however, leaves us to believe Clint might have a point and whilst setbacks will occur, liquidity will continue to drive asset prices higher. For these reasons, we are building exposures to risky assets slowly and will use market reversals to increase these positions. We are using valuation metrics to underpin our decisions and remain focused on securing income at a reasonable price. We are confident our long term super secular investments – for example growth markets and the emerging consumer – continue to be powerful themes and some of our risk budget is being spent on these. To counter the volatility and risks mentioned, our portfolios are holding gold, cash on notice and global inflation linked bonds. The latter prompted by our view that inflation risk, created by the liquidity currently supporting asset prices, is being under-estimated by market participants.
In conclusion and quoting Clint Eastwood further, the global economy and the investment universe might aptly be described as: The Good, The Bad and The Ugly.