We're in the Worry Zone But Stay Calm and Carry On

Cook: So, here we are at the start of July, what have we seen so far in the year? It's really been a pretty turbulent time for investors.

Toogood: It has, I mean everyone’s forgetting that we're actually still up for the year in most markets, so equities are up, credits are up, high yield is actually still up for the year, so it feels grim. I mean, it fell apart on March the 16th, and since then it's just been a down trend, and all the problems that arose last year have resurfaced. So it's still European debt worries; it's now probably more significantly growth concerns, specifically, so the emerging markets are slowing down; what does the fiscal cliff mean for the US? So there's lots of still that worry, worry, worry.

More importantly, that perhaps a game of two halves, the first quarter was very much let's buy the banks, let's buy the cyclicals, let's buy the economically sensitive stocks, let's buy things that say things are better; second quarter, complete reverse of that, so buying the staples, buying the telecoms, buying most defensive, and selling everything that's economically sensitive. So, there's horrendous volatility even within the trends of down and up markets, and actually the more significant factor in Q2 is actually that rotation, rather than actually just the declines which were very unpleasant. It was actually just the savage rotation, so it's making actually the job of running money and choosing a risk asset quite problematic at this point, and so it's been very turbulent, but for more than one reason.

Cook: And so underlying all this, it seems that the actual macro-environment hasn't really changed, it's fairly stagnant and we're still seeing these sort of cycles of eurozone fear rising and falling again. Has that the outlook changed or is the economic outlook still relatively the same as it was, say, six months ago?

Toogood: No, I think, from January, people were – well,I mean, our view is they were too bullish and that probably the expectations were too vividly positive again. And the other thing was people were so bearish as they entered December—funny because you had a strong run in the last quarter, but it was led by consumer staples, so it was actually a fear trade even though the markets went up, it was very technical, and people came into this year very underweight equities, so one of the reasons it was so rapid in Q1 and such a big push up in equities was because no one was there, if you like, it was technical. It didn't mean people were bullish; what's happened now is people are fretting about H2, so the second half of the year, because China has actually slowed, interest rates are now being cut in emerging markets, Europe looks at worst maybe they settle the issue in debt eventually but the growth is weak, and the US the trends have sort of muted, got more muted again. So, the general view now being actually, if it was 4% it’s now 3%; and if it was 3%, it's 2%; if it was 2%, it's 1% for whichever region you're discussing, so people are generally downgrading their forecasts for growth, and that's the reason why you've really seen another bout of stock market profit taking, because people are now worried actually about the earnings in the second half of the year. Whether the European debt crisis, risk on/risk off, whatever, now they're actually worried specifically about company earnings. It's interesting, even I'll just cite an example of Burberry yesterday saying... Burberry said actually our sales in China aren't as hot as they were. So you're seeing the signs of the slowdown and you're seeing people adjust their expectations accordingly.

Cook: You mentioned the US earlier, I mean I know a lot of people are saying, well, we're looking to US equities because we're steering clear of the eurozone, and then you talk to the US fund managers, and they say, well, we're steering clear of the US we're looking to the eurozone because it's great value. What do you think is the outlook for equities?

Toogood: Well, they're both right. The problem is they're both right. The US is expensive—relative to Europe it's very expensive, but you can sort of see why. And the problem is it’s treating geographical regions as company earnings. If you are Burberry, do you really care what happens in the UK? The answer is no, actually. You care far more what's happening in Asia. And if you are L'Oreal, France? No, you don't care about any of these things. And if you are a big US Procter & Gamble, or whoever it may be, you going to sit there and say, actually, it's the global perspective that matters. So, US as a separate autonomous region is definitely doing better than the rest of the world, but look at the differentiation in performance year-to-date, I mean, US, I think, was up 8% towards – by the second half – the first half of the year, and the UK was up 1%, and Europe was actually up 1% or something, you know it's very, very flat for Europe and the UK, and actually very strong and positive for the US. So people have recognised the relative strengths in the US. I mean, there’s the on-shoring theme, there's the energy security over time theme, and they actually are still a very closed economy, and we forget the US is virtually self-functioning. It has an export market but it can exist on its own. It can feed itself. It's getting to the point where it can have energy security, and that region as a whole including Latin America, Canada and the US can function separately. So there's still all those very bullish tacks, and  the bearish tack for the US is still the fiscal cliff, i.e. they've been spending, not having austerity, and that's concerning people. But this is the worry moment. I mean, this is what you do, you worry, and you fret, which is why the markets aren’t on 20 times earnings, they’re on a lot less.

Cook: How about from a sector point of view, I mean basic materials, for example, seem to have sort of fallen off the edge recently, what’s the, going forwards, what are you sort of seeing for these various different sectors?

Toogood: It is very hard. I mean, our theme has been it's going to be a more austere a decade. Sorry to be miserable to the camera at large, and to people in general who are listening, but it's been that for a long time. Our theme is austerity and it's accepting deleveraging, and accepting that authorities are basically doing an awful lot to try and counter deleverage you by keeping the cost of the debt you have low and allowing you to pay it off slowly, and that's really what the theme has been. So, if you think about what you want to do there, you think about secure companies that can pay their cash flow out, because they're all cash flow rich, and companies that can win in an environment which is not problematic, so if you want, very simplistically put, income funds and special situations/recovery stock funds, wherever that may be, across the world, it's that sort of approach you need to take, but we've been saying that for two or three years, and everything we have been building and helping clients build is the same thing--all-weather portfolio which is pretty much built for harder times. It's not the end of the world, just not the boom that people appear to think is ‘normal’, which by the way isn't.

Cook: So we've been focusing mostly on equities, stock markets, what about in fixed interest, what are we seeing there?

Toogood: Yeah. Interesting because the corporate balance sheets, companies aren't spending because they are fearful, that means the balance sheet is actually kind of robust. If you think about it logically, therefore you buy credit don’t you. You think about credit and say actually if the balance sheet is solid and actually it's fairly well – it's very well defined that they mostly have strong cash flow, strong balance sheets, which means they are not hugely debt-laden, they've still got debt but they can service the debt well, so credit still looks well placed. Sovereign bonds obviously are a problem because they are so low, and therefore you could lose some capital if sovereign bonds shoot up for the wrong reasons. If they go up for the right reasons, i.e., because there's growth coming back and bond yields rise, sovereign bond yields rise in respect of that, that's a good thing if they rise because they need to attract capital because things are so bad, different conversation, we haven't got time for that one, we'll do that another time.

But credit looks fairly well position. High yield is not cheap at this point, but again the same thing applies, the supply side is good. There is not too much issuance going on, and the balance sheets are generally quite favourably disposed, default rates are quite low, et cetera, et cetera, et cetera. So, it’s a reasonable coupon and actually again the same point, given the corporate sector's relatively rude health, why wouldn’t you stick with that? And so it still looks fairly well placed barring complete economic calamity.

Cook: So how about alternatives, commodities, property…?

Toogood: Harder. Property is fairly fully priced. I mean, the biggest issue with property is that such a bifurcation sort of systematic of this sort of trophy assets, quality asset kind of thing. Prime is very expensive, and you know Bond Street in London is still going at 2%, 2.5% yields. I mean, it's where it was in the crazy pricing of ’07: blind buying, no one cares, I just want to own a shop in Bond Street. And then you’ve got sort of the outer regions of London and beyond and outside the – in certain very difficult office environment, very difficult industrial environment, and there you're seeing the yields continue to move out, i.e., capital losses. So, property looks dull to be honest and doing it direct property format with a fund structure is hard. So, the yields are at 3%, 3.5%, it’s a bit of challenge.

Commodities, function of the economic cycle, the demand side looks weak, even though the supply side in things like copper, it looks okay, i.e., positive, i.e., there is not much of it. And it will always respond to a view of demand and the view currently, though that may not always be the case, is that it’s going to be a bit weaker, hence you've seen some price declines. But don't, remember, you got the terrible [yield] balance for fund managers and for people in general, the authorities know this and they’ll continue to do as much stimulus as they can. It’s just how much that helps in the medium term. It can do a short term fix, and so you may see some volatility in these as they spike, and people say ‘ah, more QE, more whatever it is that’s going to help’, but eventually they'll just fall to the natural level of demand because you can’t keep fluffing it even though they try hard.

Cook: So you've mentioned that really you're trying to help your clients cater for what’s going to be several more years of hardness after several years of hardness.

Toogood: Yeah. Well…

Cook: Is that what investors have got to do then, just sort of sit tight and…?

Toogood: Yeah. They’ve got no choice. I mean, and no one wants to hear it, but the truth has been and we've been very constant on this for a long time, it’s going to be a deleveraging world. I mean, you only have to look at the Scandinavian banking model, when they had their crisis, Canada had the same thing. It’s a long workout, it takes time, it’s not going to be the end of the world and the European debt crisis is probably the last thing to deal with. There is a loss of capital there, you have lost money in things like Spanish property, et al, et al, et al. There's certain structural rigidities in these peripheral regions that need to be addressed as well. Once you get through that, you're there, but it's not going to instantaneous gratification, but once you do that you have got on top of most of the debt issues. You have got a cyclical slowdown in emerging markets that will change eventually, that will unwind and get better again. But it's a confluence of things that make everyone feel very bad. The world hasn’t yet ended, but it’s not going to be borrowing today for tomorrow's joy, and people just have to adjust their expectations. But you know what, if you're getting a 4% dividend buying nice companies, solid companies or winning companies, wherever that may be, in the medium term it’s going to be fine but it’s going to be all weather, think about in those terms, don’t do it too active, stick to the knitting, either buy your trackers or buy your good fund managers who you have faith and trust in, you’ll be fine.

Cook: So don’t freak out, stay calm and carry on.

Toogood: Stay calm, keep calm and carry on, exactly.

Cook: Peter, thanks very much for joining me.

Toogood: Pleasure.

Cook: For Morningstar, I'm Holly Cook. Thanks for watching.