What Happens When Liquidity Dries Up?Economics
As central bankers raise rates across the globe in their fight against inflation, institutional investors are turning their attention to liquidity. In this new chapter of global political economy, a world drained of liquidity is a world where assets are no longer priced on fundamentals.
Being short liquidity means sellers of assets will by necessity take what they can get in order to meet their commitments. Or put differently, being long liquidity facilitates the purchase of quality assets at deep discounts to intrinsic value.
This presents a dichotomy for institutional investors:
An ALM driven investor will be guided by a series of strategic asset allocation benchmarks and associated risk budgets. Which empirically provide a confidence level that their assets will generate enough returns to cover their current and future obligations. So the tendency is to sit out the storm.
But there are hard core investors who see the removal of liquidity from the global economic system, as an opportunity to pounce. Their research inside RFPnetworks is crossing all asset classes. Searching each of the 11 feeds for terms such as "cheap", "intrinsic value", "discount", and "distressed".
We see danger ahead. Markets are still too high, and protection is expensive in an increasingly nervous world; common sense suggests one should invest conservatively, and in safe assets. In a world where people find themselves without the ability to pay commitments as they arise, forced selling drives prices. Among risky assets like equities, one of the counter-intuitive things in a liquidity crisis is that securities perceived as safest and most liquid go down sharply, because investors are forced to sell what they can, not what they want to. We therefore regard plentiful liquidity in the portfolio as overwhelmingly attractive; it allows us to make the most of the opportunities that arise in the aftermath of a crisis. But first we have to get through the storm.
EMD research inside RFPnetworks therefore tends to receive a relatively large proportion of our daily traffic. And currently, there seems to be a lot of interest in Hard Currency EMD. Which is interesting given there is a lot of information to digest from the YTD Sep 2022 numbers.
There is a lot of new information to digest on EMD Bond Markets.
Out of U.S. Growth Stocks and into What?U.S. Equity
U.S. Growth Stocks have fallen back to earth this year, and even more so then the broader index. The combination of accelerating inflation and interest rate hikes has switched investors risk-on trade firmly off.
Investing in companies run by new, unproven, or inexperienced leadership teams, building businesses built on disruption and the promise of abnormally high future earnings streams has lost followers. The question today is who are they now following?
Why is EMD Local Outperforming Hard Currency Bonds?Emerging Market Debt
The default allocation to EMD tends towards local currency bonds. The market is larger than hard currency bonds, more liquid, and of higher quality. But are you getting paid for your risk today, and if so, where is the outperformance of local currency bonds coming from?
With 10 year treasury yields breaking 4% for the first time since 2007, and EM Sovereign Bond prices falling to levels not seen in 20 years, investors are taking another look at EM bond markets. The fixed income feed inside RFPnetworks was dominated last week by new papers dissecting the universe: The risks, the drivers of performance, and the outlook for EM Fixed Income markets versus developed markets.
An allocation to high-quality, developed market government bonds continues to play an important role in reducing the volatility of a well-diversified portfolio. However, there is no getting away from the fact that, despite recent rises, yields in developed country bond markets are low by historical standards and often fail to compensate even for relatively modest projections for inflation. Given the secular forces that have led to the long-term decline in equilibrium real interest rates, this situation is likely to persist. An allocation to Emerging Markets Debt (EMD) can complement traditional fixed income by enhancing long run returns and acting as an important diversifier within global portfolios.
What's Motivating Circular Economy InvestorsESG
Plastic Soup. Climate Change. Water Shortages, Food Shortages...For many these are important, but they are tomorrow's issues, not today's. Yet what these many fail to realise is that they are also today's biggest investment opportunities. Do these three things:
1. Look at the stats on global consumption/resource utilisation, population growth, sources of greenhouse gas emissions, waste and plastic recycling, water loss and demand...
2. Look at how government views on taxing externalities has changed over the past 20 years, and extrapolate forward.
3. Take a look at some of the companies at the cutting edge of food, energy and recycling solutions, then talk to some early investors and strategic allocators to the circular economy.
Within 30 minutes, what you thought were tomorrow's issues, may become today's portfolio priorities.
Diversification has been tough of late with bonds and equities exhibiting co-integration. So the search is on for asset classes that can solve this problem. The research being performed inside RFPnetworks is not necessarily about mean-variance optimisation. It's focused on qualitative causality. Why is one asset class uncorrelated with the current portfolio basket. These insights are pulling investors towards the Chinese Equity onshore market as an underappreciated diversifier.
It seems as though Fed Guidance has moved from being behind the curve, to springing off the curve...at least that is the view of many economists in the research feeds inside RFPnetworks.
Demographics and U.S. CREOffice Real Estate
The stable historical relationship between office demand and employment growth has been challenged by hybrid working, with some estimates pointing to a 4% resultant increase in office vacancy rates. But investors attention has now turned to a different relationship. The impact of demographics on U.S. commercial real estate. The numbers are striking.
The cross-generational characteristics of the labour market is changing. Whilst the millennials over filled the work force after the Global Financial Crisis, the baby boomers were also still hard at work. Roll forward to today, we have a situation where baby boomer retirement is not being compensated by enough Generation Z labour market entrants. Added to which is a declining population not being compensated by immigration growth in the U.S., making for even tighter future labour markets.
And as the labour market tightens, employers will have to lean in to the desires of the workers that remain. Both in terms of the city in which they locate their offices, and the attractiveness of the working environment to Generation Z employees.
Identifying opportunities in U.S. Commercial Real Estate in the future, may be less about employment growth, and more about identifying assets that create an attractive working environment for Generation Z employees.
US commercial real estate (CRE) investors are well-versed in the importance of economic growth to property investment performance. Focus on the Covid-19 recession, policies to truncate it, and the path of recovery have dominated the attention of analysts for more than two years. Macroeconomic factors continue to dominate attention now, well into 2022, as inflation in the Covid-recession’s aftermath complicated by Russia’s invasion into Ukraine have taken the spotlight. All eyes are now on the prospects for the US Federal Reserve (Fed) to accomplish a soft landing. Looking further ahead, US CRE will confront another challenge embodied in weakening demographics. In the paragraphs below, we identify the components of weakening demographics measured nationally and highlight differences across US metro areas. The differences illustrate the importance of careful metro market selection to counter demographic headwinds in the years ahead.
Who Are The Best CEO's Of Listed Companies?Global Equity
Recessions put the Corporate C-Suite to the test. When the world is growing, rates are low and inflation under control, steering the Cruise Ship into sunny harbours is easy. But when a macroeconomic tempest takes hold, and your port of call becomes innaccessable, calmer waters and a new destination has to be found. So what is the smart C-Suite doing?
Capital Expenditure is the fuel that powers future earnings. Directing that investment into the themes that will determine the company's success over the next decade is where the thought capital is now being deployed. Two mega themes that touch almost every company globally are Deglobalisation and the Energy Transition. But which leadership teams are embracing change and and investing for tomorrow today? And who are being recognised as the best CEO's of Listed Companies?
How To Outperform Equity IndicesGlobal Equity
One way to outperform an index is not to underperform the index? This is a sine qua non, but in no way useful. Or is it?
Manager Selectors are notorious for looking at performance. But are they looking at the right performance? And what it the right performance? An Information Ratio? A Sharpe Ratio? 3 years? 5 years? 10 years?
This question is of fundamental interest today. With the VIX breaking 30, the S&P 500 hitting it's lowest close since Nov 2021, and year to date global equity indices glowing red, the characteristics of investment manager's performance track records is getting more attention.
And in particular, the usefulness of adding products to their multi-manager portfolios that exhibit up and down market capture in proportions that are different to their existing manager line up.