Although stock markets have rebounded sharply since last March, it is unlikely many investors are feeling complacent--not with unemployment rates still steep and nearly every state government facing severe budget cutbacks. Late last week, attention-getting policy decisions by political leaders in the United States and China added further uncertainty to the mix.
At least the most critical risks to the global financial structure have been addressed, you say? Not so, according to two international-fund managers who pay more attention than most to the world's financial, political, and socioeconomic issues. In the minds of Rudolph-Riad Younes of Artio International Equity and Artio International Equity II and Oliver Kratz of DWS Global Thematic, there's trouble brewing.
Warning signs abound
Younes is dismayed by the response to the global financial crisis that
began in 2007. As events spiralled out of control, he thought
cash-strapped governments had no choice but to allow the most troubled
big banks to essentially go bankrupt and then nationalise them. The
banks then would be reined in, and consumer spending would be muted for
years. And, given the dire state of governmental finances in so many key
nations, fiscal policies would have to change as well. Most notably,
taxes would have to increase, spending decrease, or both. Higher
interest rates would also be required so as to avoid a repeat of the
conditions that helped create the housing bubble.
Younes was caught flat-footed when none of this happened. (His funds paid a price in their performance.) As he states in his recently released shareholder letter, "We did not anticipate that [the US] and the rest of the world would so quickly re-embrace and encourage the borrow-and-spend policy ... which had brought the world to the brink." In his view, the results will not be pretty. "The world is re-embarking toward further global imbalance, postponing the painful and necessary adjustment." Can't we have a "soft landing"? No. "Having witnessed failed soft-landing attempts for the [Internet/tech] and real estate bubbles, we fear a similar fate to this one." Governments and central banks should recognise that "sacrifices must be made sooner or later."
The most obvious current bubble he sees forming is in emerging markets, specifically China and India. The overwhelming enthusiasm for these markets and amount of investment pouring in to them help lead him to that conclusion. China and India "are today's version of the Internet" craze, he states, and "we all remember how the Internet craze ended--soberly and painfully."
Not all darkness
Younes isn't simply a gloom-monger, however. He's not predicting the end
is near. When speaking with Morningstar in early January, he conceded he
had no idea when the reckoning would come. He said that seemingly
overvalued assets can stay at lofty levels a long, long time and
admitted that he and his colleagues have an unimpressive record at
correctly guessing when such frenzies would end.
Therefore, Younes is keeping watch on several areas for warning signs. One key for him is the level of stock prices in emerging markets, and he does not consider valuations extreme as yet. He's also on the lookout for trade tensions that he expects to develop as countries try to adjust to global "imbalances." Third, he thinks China has overinvested in the wrong areas and that poor allocation of capital will cause trouble there eventually. But given China's "command driven economy with a closed capital account," Younes wouldn't be surprised to see the China train keep rolling for quite a while yet.
With the signals not yet flashing red, Younes actually sees opportunities available in various places. In Europe, he likes blue chips with brand names, saying they're available at reasonable prices because global investors have become unnecessarily spooked by the acute financial difficulties besetting Greece and Ireland. Regarding sectors, he thinks leading food producers are well-placed, and--given that China's government can continue to propel that country's high growth rate for a time--he thinks metals and mining producers around the world are still a good place to look. (He also considers metals and mining stocks "a good hedge against central bankers' malfeasance.")
The China puzzle
Oliver Kratz of DWS Global Thematic doesn't share all of Younes' views.
But on China (and emerging markets more generally), the two are of one
mind. Kratz has cut back drastically on his direct emerging-markets
exposure, which he told Morningstar last week was around 10% of assets,
down from as high as 30% in the past. One concern he has is simply the
overwhelmingly favourable consensus in favour of Asia's growth
prospects, visible both in investor comments and in investment flows. He
sees a dangerous unanimity in which scepticism has been abolished.
More specifically, Kratz considers the rapid growth of the money supply in China a warning sign, and he feels especially uneasy simply because he doesn't trust many of the numbers coming from that country. (He likens the Chinese government's economic reporting to the dubious accounting that used to emanate from the Soviet Union.) Like Younes, Kratz cites illogical capital allocation by the Chinese government as sowing the seeds for a future crisis. He is still finding select opportunities in emerging markets but says in general the stocks in such regions cost too much now.
Therefore, also like Younes, Kratz currently prefers to tap into the developing world's growth by owning American and European giants with vast emerging-markets exposure. He says these companies are selling more cheaply than their emerging-markets counterparts even though their risks are milder, in his view. He cites Procter & Gamble, McDonald's, Diageo, Nestle, and Johnson & Johnson as some of the companies fitting that description.
One other area Kratz highlights might surprise people: Japan. "The market had decided Japan is not in Asia," he wryly told Morningstar. Most investors, he said, consider the country hopelessly mired "in its own island of misery." He disagrees. The knowledge base in that country, plus what he considers an almost inevitable weakening of the yen, will benefit many of its stocks. Japanese banks especially pique his interest; he bought a bunch of them late last year.
Resumes, please
Of course, scores of investment professionals with varying levels of
name recognition can spout views on global economic and market
conditions. Why listen to these two? They're certainly not infallible.
But among international-fund managers, they're among the few that can
point to a long history of thinking carefully about the effects of macro
trends and issues rather than saying they're simply stock-pickers
looking at company fundamentals.
Moreover, both have strong records putting theory into practice. Younes has been running Artio International Equity since 1995, and it has one of the best records of any international fund over that lengthy history. Kratz' record on his fund is shorter, but its return since he took it over in 2003 trounces the world-stock category average and world-stock indices.
That doesn't mean they're right. But it does indicate they're well worth a listen.
