China under stress
This is the backdrop for Tilney BestInvest’s six major themes for 2016 (listed on page 44). Of these, Lewis believes that the biggest issue globally is the capital misallocation happening in China. This means the potential for a hard landing and a devalued currency. He believes this will sustain deflationary pressure and stresses in emerging markets and Asia.
He points out that it took US banks 100 years to build up the liabilities that Chinese banks have built up in the past seven years. “You simply can’t allocate that much capital that quickly,” he says.
“There is huge over-capacity. There is a non-performing loan issue. As a result, we are underweight Asia. The whole economic ecosystem is linked to China growth.”
In this environment, the Federal Reserve is unlikely to raise rates meaningfully. “The world can’t cope with a strong dollar,” he says. The European Central Bank, Japan and now the UK can be expected to maintain or extend their monetary easing policies, but the market and economic impact will be muted.
Lewis believes central bankers’ hands are tied to some extent, and that monetary policy is increasingly creating inequitable distribution of wealth.
“It has driven up asset prices and wage growth has not taken off at all,” he says. “Many people are worse-off today than in 2008. It is an unsustainable situation. The wider electorate is fed up with the political elite and central bankers. They are angry, even if they’re not sure what they are angry about. The ECB, the Fed and the Bank of England could all come under attack.
“The asset owner is proportionately wealthier than the non-asset owner. In the UK, the government is well aware that home ownership is becoming very divisive. A whole generation will soon be priced out of the housing market and the government has been trying to support house prices for too long.”
He believes Brexit is the first manifestation of a rebellion likely to be seen more widely across the globe as inequalities grow. This is likely to force a change in policy from governments from monetary to fiscal policy.
Lewis says: “We are seeing a change in the way policy is set, from central banks to fiscal policy. Brexit was the first sign that policy was changing – moving from Wall Street to Main Street – this will be a headwind for risk assets.”
For Tilney Bestinvest, this environment has seen a reduction in risk across the group’s portfolios. Equity weightings have come down in favour of cash. The group is overweight in areas such as Japan and Europe, where monetary policy continues to be supportive, while, at the same time, it is underweight emerging markets, Asia and the US.
Lewis is neutral on bonds, but has a strong preference for sovereign bonds over corporate credit. In particular, the group has a zero weighting in US high yield, given its exposure to the oil & gas sector.
He has been reducing the group’s UK gilt exposure more recently, after a long-held overweight position. This is partly on valuation grounds, but also on concerns that inflation may start to pick up a little if fiscal policy is called upon to boost the flagging economy.
The group has also been reducing its UK commercial property weightings. While yields remain attractive, says Lewis, there are concerns on liquidity.
