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Beyond Brexit: Focus on long-term trends
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THE ETF INVESTOR
Investment management insights from a leading Canadian expert.



By Tyler Mordy  | Thursday, August 11, 2016


 



Britain has voted to leave the European Union. No one can be surprised. In fact, the polls were so close, either outcome would not have been a shock. As usual, popular perspective is driven by hype. The focus being promoted today, of course, is an increase in global uncertainties. Fears are being fanned. That sells newspapers and keeps investors distracted.

Not to be denied is that financial market volatility is high. The European Union (EU) has taken a blow. More are likely to come. There are numerous anti-immigrant parties in various European countries that are also auguring to leave the EU. Uncertainties with Europe will continue, and anti-populist movements around the world will gain further traction.

Since 2008, we have argued that post-financial crisis periods are a different animal. Investors, still carrying crisis-made scar tissue, tend to cling close to shore. Endless financial crisis fears prevail – whether U.S. fiscal cliffs, Chinese devaluations, Euro banking insolvencies, and so on.

The narrative keeps shifting, but a negative bias lingers and volatility remains elevated. This time has not been different.

Long-term super trends

All of the above should be viewed opportunistically. During times of shorter-term uncertainty, it is critical for client portfolios to remain oriented toward longer-running “super trends” (i.e., a 3-5 year view).

In that spirit, consider three that will have an outsized impact on client returns in future years:

China’s debt crash: waiting for Godot

China’s global image, assiduously promoted by the world’s ubiquitous bears, is of a failing economy beset by a collapsing currency, panicked capital flight by investors, and, as widely advertised, debt levels teetering on the brink of disaster. It cannot be ignored that China has an eye-watering amount of debt, reaching over 220% of GDP by the end of 2015. But the fundamental reason behind this credit surge is rooted in its high savings and banking-centric intermediation system.

Chinese households have long been the primary providers of savings in the economy, and their assets are far larger than liabilities. Thus, viewed from a balance sheet perspective, the debt situation is much less dire than commonly perceived. Further, the critics ignore that most debt has been used for infrastructure buildup rather than funding consumption (imagine that in any Western country).

Comparisons to Japan are also wide off the mark. Japan’s corporate debt-to-asset ratio topped out at 78% in the early 1990s. After a 26-year balance sheet recession in Japan, Chinese corporates have comparable debt-to-asset ratios.

Like Vladimir and Estragon waiting endlessly for Godot in Samuel Beckett’s play, Chinese pessimists will likely have to wait a very long time to witness a China debt crash. But this China debt view has punished Chinese stocks and has priced in a severe credit crunch. Yet exposures to Chinese assets should be core holdings in globally balanced portfolios.

Canada and Justin Trudeau: can the son rise again?

In the last few years, Canada’s star has fallen, and several macro headwinds have surfaced, including a fragile housing market, weak private-sector job growth, and the end of a multi-year uptrend in commodity leadership (notwithstanding the rally in oil this year). But now, our newly elected anti-austerity prime minister, Justin Trudeau, has revived hopes that Canada can regain its former glory, funded in part by “responsible deficits.”

While Trudeau’s “sunny ways” have engineered some optimism, the more impor­tant story for Canada is the ongoing commodity bear market. Politics cannot change that meaningfully. Since oil now accounts for half of Canada’s production-weighted commodity price index, the collapse in crude oil prices represents a big downside risk to the outlook for business operating profits. The potential hit to investment, incomes and employment will keep the Bank of Canada on the dovish side for some time.

Meanwhile, Canadians continue to be over-exposed to domestic assets. This is all going into reverse as Canadians scramble to embrace global diversification. In fact, Canada is now a creditor to the U.S. for the first time on record, reflecting Canada’s renewed love affair with assets south of the border. The stock of U.S. assets held by Canadians in the fourth quarter of 2015 – everything from corporate acquisitions to portfolio investments – exceeded assets held by Americans in Canada for the first time since 1990. Expect this trend to continue.

The unbearable lightness of central bank stimulus

Milan Kundera’s post-modern masterpiece (book) from 1984, The Unbearable Lightness of Being, perfectly captures the human paradox of lightness and weight. At times, we sense the transient nature of life, recognizing ourselves as mere participants in a vast unfolding universe. The world feels weightless. Other times, a heavier hand reminds us of a greater significance. We tighten our belts, reluctantly conceding an important role in the grand cosmos. Suddenly, our existence is heavy again.

Today, many investors may be experiencing their own existential struggle. On the one hand, global central banks have created a fertile environment for speculation of all stripes. Quantitative easing and its monetary offshoots have the effect of tethering interest rates to zero, coaxing savers and investors further out on the risk curve. The world’s central bank chariot wheels have not just hit the ground – they have gone through it and are burrowing deep into the monetary unknown. More than a quarter of the world’s population now lives in countries with negative interest rates.

Meanwhile, the real economy – hobbling along at subpar growth rates – serves as a sobering reminder that we have yet to arrive. To be sure, this is a new environment for investors. Suddenly, public policy is a major risk factor for portfolios. Anticipating the type of environment policymakers will create can provide useful signals for the road ahead (note: that’s easier than solving the world’s problems!). Those looking to postwar precedents for guidance will surely be disappointed.

Furthermore, the culmination of low interest rates and slow growth results in a wider set of possible future scenarios. While market participants continue to be polarized between extreme “bullish” and “bearish” views (neither being our core scenario), portfolio insurance should always be in place. In the words of financial historian Peter Bernstein, “if you like everything in your portfolio, you are not adequately diversified.” That means broad global diversification with an emphasis on protecting downside movements.

Looking ahead, despite recent events like Brexit, our Investment Committee’s outlook has not changed significantly. In fact, it has confirmed our longer running thesis: We continue to live in an era of new realities. The best approach for investors is wide global diversification with exposures tilted to longer-running su­per trends. We remain committed to that investment discipline to ensure our clients meet their financial objectives.

Tyler Mordy, CFA , is President and CIO for Forstrong Global Asset Management Inc. , engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in ETF.com . Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com . Follow on Twitter at @TylerMordy and @ForstrongGlobal

Notes and Disclaimers

© 2016 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

 
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