A non-consensus view investors should be thinking about

Big business is back and that's a great thing for credit. Partially driven by stimulus, and partly by broader economic confidence, people are willing to spend again and in turn businesses need credit. But even when the music stops playing, Pete Robinson, head of investment strategy, CIP Asset Management said there are "nice places to hide out" and protect your investment from being stuck on the other side of the confidence curve. Floating-rate credit, he explains in the video below, is a useful hedge against rising interest rates, which could be just around the corner.  

But just as 'unprecedented' was the catchword of 2020, inflation is today's the buzzword in markets. This is why deflation (that's right, not inflation) was the last thing we expected to hear about from Robinson. 

Recent data out of China, which is only released every ten years, showed that birth rates are the lowest they have been since the 1960s, with similar numbers being echoed by the US. In 2020, only 10 million children were born in China, compared to 17.23 million in 2017. Additionally, with immigration levels dropping, this could see the slowing of domestic economies in the long term. Observing Japan's ageing population, Robinson said, in the long term, investors should be more concerned about deflation as seen in Japan, than inflation. 

In this video, Robinson discusses why it's important for investors to consider his take on the current macro environment and explains the benefits of floating-rate credit. 

Transcript

Peter Robinson: It's a really interesting question around what we're seeing in terms of the macro trends in the market right now. I think one of the things that we're looking at, at the moment, is just the tightness of credit spreads. What I mean by that is the return that we're getting from taking credit risk in our portfolios. Right now, you might be surprised to know that credit spreads are actually tighter than where they were prior to COVID, prior to the COVID outbreak. Actually, the returns that we're getting on credit are lower than at any point since the Global Financial Crisis.

What that's driven by really, I think, is extremely strong monetary and fiscal support that's hit the market. We've had the $90 billion JobKeeper program. We've had $35 to $36 billion withdrawn from people's super, favourable tax policy, and really that's supported markets. What's really interesting to us is that if you look at what's happened over the last 12 months, we've had two quarters where we've had less than 1,000 businesses enter external administration. In the prior 20 years from that, that had only happened once.

Clearly, businesses are actually doing quite well in this environment. But this policy, I think, has implications. Some of those implications revolve around market liquidity. We're thinking a lot about that at the moment. You can think about it this way. You think if the Fed is buying right now, everyone's buying and market liquidity is fine, or at least it appears fine, but when the Fed stops or people think that it's going to stop, everyone stops buying. No one wants to be on the other side of that trade. That has really serious implications for market liquidity.

Absolutely. I think the fear of QE tapering is certainly going to have a substantial impact on spreads, and I think on risk assets generally. So much of the market right now is based on a discounted cash-flow valuation. Really, the key input to that is the level of long-term interest rates. If you think about stocks in the tech sector that effectively you're discounting a future profit at some point, 20 years maybe from now, and you're discounting that back at a very low discount rate, that profitability can seem quite high on a DCF basis.

So even tapering, and higher long-term interest rates, can have implications for those sectors as well. We actually think floating rate credit is quite a nice place to hide out because you're not taking that exposure to tapering and higher interest rates. Really, you're looking at how those companies perform, and what the implication of higher interest rates are from a bottom-up fundamental perspective.

Floating rate credit, essentially you're paid a credit spread or a return over and above a base cash rate. That's a very short-term interest rate. So if long-term interest rates increase, the rate that you receive on your debt doesn't increase, you just get paid what the short-term rate is, plus a credit margin. What that means is, if those long-term interest rates increase substantially, the price of your floating-rate credit doesn't change, it's not tied to long-term interest rates. Whereas if you buy a 30-year government bond at an interest rate of 1.6%, and that interest rate increases to say 2.6%, you can be sitting on a fairly substantial capital loss on that position.

When we think about forecasting of interest rates, the first thing we start with is our own uncertainty around the future direction of interest rates. By investing in floating rate credit, we really avoid having to make a call, a directional call on what we think interest rates are going to do in the short to medium term, but in terms of the lower-for-longer camp, I think one of the things that we thought about this week in particular was demographics.

If you think about demographics over a really long term, we had data out of the US and China, since the start of the [inaudible 00:04:03] to really slowing birth rates in both the two largest economies in the world. In fact, in China, birth rates were the lowest, since the 1960s and only 10 million births took place in China in 2020. This data only comes out once every 10 years. These trends towards an ageing economy, clearly they're not inflationary.

So over the longer term, we still have a view that inflation remains contained, but in the short to medium term, I guess our view is more nuanced. Clearly there's been a huge amount of fiscal and monetary stimulus, and there will be a rebound as inflationary pressures hit our economies. In Australia, for instance, there's a million less people projected to be in this country over the next few years than was projected prior to the COVID outbreak. That's going to have implications for things like supply of labour, and wages, in our own domestic economy, which is effectively closed right now.

I think that certainly, that's historically been the case, that ageing populations... if you look at Japan, it's the prime example of where an ageing population has had a deflationary impact. But I think that there is a huge degree of civil unrest and that seems to be growing at the moment. In China, you have an issue of a population that I think is about 51% to 52% male, so a lack of females. What that does, what unrest that creates in those economies and what the implication of that is, is pretty hard to predict.

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