Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by John Pattullo, Manager of the Henderson Strategic Bond Fund.
Hello, John.
John Pattullo: Good morning.
Wall: So, at the tail end of last year you were one of the few people putting their head above the parapet and saying that inflation was not going to be a big problem as many were predicting. In fact, we were entering into deflationary environment. And you didn't get that too far wrong, did you?
Pattullo: No. I mean, Jenna and I have been of the view for years that the world, Europe essentially, is turning Japanese as in low growth, low inflation, suppressed volatility and suppressed defaults. And that's exactly what has happened. The Trump thing confused investors I think. We were fairly dismissive of it. We did a lot of reading and were frankly uphold actually by all the investment banks we read.
Whatever model you put Trump in, good Trump, bad Trump, maverick Trump, whatever, most of them were invoking a material change in growth or inflation, slightly to our surprise. Having said that, we were respectful of the Trump trade because we didn't know. I mean, you can't ultimately know. So, we did shorten duration a little bit with a view to getting longer again because we didn't think that was a regime change.
The other thing about the Trump trade was it was basically, because China has reflated the world in early 2016, he got elected when the world was ticking up in a synchronized global economic activity and he took all the credit for it even though he hasn't really done anything. So, all the equity managers were relict on this and obviously, there was big rotation in equity markets for a while until year end of 2016. But 2017, it's actually the value – the growth stocks untag have been performing and bonds have been performing again. So, we do feel pleased we called that correctly for our clients.
Wall: And the other thing that slightly confused matters were commodity prices, weren't they? The fact that oil doubled and many people said, well, this is it, this is inflation. New norms of 3%, 4%, double what the bank is recommending. And actually, that hasn't come through?
Pattullo: Yes. And I think virtually all the street analysts had 10-year treasuries up at 3% or higher. And some of the leading banks still have four or five U.S. interest rate rises penciled in and we think you'll get – well, you get one this week, you might get one more and we think that's probably it. I think the equity community, if I could be so bold, some of them get a bit confused with headline inflation compared to core.
So, the oil price doubles if headline inflation goes up; mathematically, of course, it does. The bond community is a little bit naughty because when the oil price halves, they will get a bit deflationist. Whereas if you look at underlying core CPI, it hasn't really done anything. So, always look at core. Don't get distracted by what's going on in energy and oil. But you can kind of felt that the equity market, well, there's a reflation trade coming. I've been waiting forever. And here it is, it's fantastic. But it didn't actually last very long at all and we think it's faded pretty fast.
Wall: So, the first half of this year has certainly been that picture. The question now, however, is what the next half of this year and indeed, going into 2018, because, well, with any call you can only be right until you're wrong?
Pattullo: Yes. And markets are pretty much shockproof events. So, even this time last year, this secular stagnation that Larry Summers' thesis got almost too mainstream. Everyone's bought – bond yields were really low, U.S. treasuries were down at 1.3% and then they doubled from 1.3% up to 2.6%. Today, they are at 2.2%. So, is it in the price? Well, I think, quite a lot of it is in the price. Having said that, everyone says, well, the uncertainty of bond market got to end tomorrow; unless we'll sell bonds, it's all disaster.
Wall: Which they've been saying for about…
Pattullo: …forever. And all our clients are shorter bond, they are all shorter duration, all of them, almost to a tee, because we travel up and down in the country. We've been in America travelling as well. And Jenna has got the same feedback from our American clients as well slightly to our amusement. And a lot have gone into alternative products, peer-to-peer, infrastructure, lots of so fashionable stuff which we purposely avoided, all that stuff and it's a short-duration asset class. So, you haven't got the benefit of duration when risk is off.
So, I think, quite a lot of it is in the price. Well, I'm just not convinced it's just because the 5-year down trend is long ended too, but it doesn't mean you suddenly get a massive uptrend on other side, maybe a basis for the next three or five years. And (indiscernible), you get a little bit of a cyclical uptick and bonds sell off there, and then you get the long-term structural demographics, digitization, too much debt. All this stuff we've spoken about for years will reassert itself.
As of today, I think, treasuries are kind of fair to cheap, but they have moved a bit and the positioning has moved. So, everyone was massively short when the economic data was just turning over and obviously there was a short squeeze, bond yield rallied, prices up. And as of today, I think, there's a bit more in it actually. But you can't be more bullish when yield are at 220 than you were at 260.
Wall: John, thank you very much.
Pattullo: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
