Transcript
Tom Merchant:
Great, so welcome all to our Q2 investment update. My name’s Tom Merchant, I’m a Partner and Business Development Manager here, and I’m delighted to be joined by David Cooke, our Chief Investment Officer. Afternoon, David.
David Cooke:
Good afternoon, Tom.
Tom Merchant:
Good. So, interesting quarter to say the least. I think if you saw the sheer amount of column inches written about it, it’s fair to say that you would think we’d be in a very different position at the end of the quarter that we were at the beginning, but it’s safe to say that maybe wasn’t the case. So I thought to kick off, it might be helpful if we can give those a sort of retrospective look back generally what happened, if possible.
David Cooke:
Yep. Well, it’s going to be quite a long answer, Tom, so please interrupt if we need to expand a little bit more. You’re quite right, because if one of our clients are gone at holiday at the end of March and come back at the end of June and looked at the portfolio, it would’ve gone up a little bit, probably. And if you looked at market indices, you’d think there wasn’t much to see here.
But sandwiched in between in those three months, we had the most enormous equity market crash, followed by an enormous recovery in May, with sufficient momentum to take us through a war in June, to end up unscathed, ahead of where we started, and with sentiment a lot stronger than where it was and where we began the quarter.
So there was an awful lot that happened in between. And the roots of this all began on the 2nd of April with Liberation Day in the United States, which is when the New American administration announced a series of tariffs on the rest of the world, and these tariffs were much bigger, maybe about twice the size than people had expected.
So, an already nervous market quickly started to fall very sharply, this is equity markets mainly, as they started to factor in the chances of these taxes causing a slowdown in economic activity around the world. And initially, the Trump administration tried to brazen it out, but then they very quickly realised that one of their first policy actions in tariffs could actually cause a recession in the United States and in the rest of the world, which is not a great look.
So they began to back away from these very aggressive tariff announcements, announcing 90-day reprieves for everybody in the world, apart from China. And then a few weeks later, announcing a reprieve from China as well. And the market started to recover strongly as a narrative developed. And this narrative is called TACO, which is Trump Always Chickens Out, which is the market’s way of saying, in shorthand, that under pressure, this administration is prepared to walk back from extreme policy positions. In British language, that means that President Trump’s bark is worse than his bite.
And once that realisation started to take hold, and also the real economies around the world had remained relatively robust in this period of April and May, then we had a really strong momentum in stock markets throughout May and into June, which was enough to let us ride out the implications of the Israel-Iran war, which saw a little bit of volatility in oil markets, but then Iran was basically shrugged off by global investors as a serious risk.
I think mainly because they took the view that the Iranians just do not have a lot of good policy options to retaliate. And their path, the most likely path was to de-escalate, which in the end, as we make this recording, is what they did.
So you put all that together with one other thing that happened that is important, which is that in the government bond market, the very long maturity end, the 30-year end, we did see a sharp increase in borrowing costs for some important governments like the Japanese, which had traditionally had very, very low interest rates, which the rest of the world sourced a lot of their borrowing in Japan. And suddenly, these prices started to unmoor a little bit.
Now, eventually it calmed down, but it’s kind of like the long end of the government bond market, which is a key foundation of the financial assistance, like there’s little thunderstorm in the distance, which passed without anybody getting wet, but it’s still rumbling on in the background. So it’s been busy, as I said.
Tom Merchant:
Incredibly busy. And just to pick up on a couple of bits there, just because I had a conversation with, actually, a client not the long about Trump, and they raised a really good point. So I appreciate the TACO is maybe a left leaning view of his way of doing policy and getting into debates with other countries, but others will see it as brinksmanship.
So, taking people to the edge, that this is his MO, always is. Say something really extreme and then dial it back, but no one seemed to view it as that. When that happened, people took it very seriously at the time. Are people still finding him unpredictable in terms of not being a pattern and that’s causing quite a bit of volatility whenever he does something?
David Cooke:
Yes or no, in the sense that uncertainty is still high about American policy action and how it impacts the economy, but it’s not as high as it was. So that level of uncertainty has decreased. I think what surprised people about the tariffs was not only that, let’s say, the average level was twice as much as people had thought only a few weeks previously with all the leaks that go on in Washington, but that there was no real industrial logic behind it, in that a lot of people who had trade deficits of the United States were still tariffed aggressively, and the maths was also pretty shaky.
So it was kind of a very flaky policy and you’re wondering what on earth was going on. And it was only under the pressure of falling equity markets and wobbly bond markets, and the very real risk that a policy action, a flagship policy action was going to cause a recession that they started to back off.
There were other things as well. The administration was very aggressive on the competency of the chairman of the American Central Bank, the Federal Reserve, and President Trump talking about having him fired. But very quickly walked back from that when informed that the bond market would not really like this degree of political interference with an independent central bank. There were threats to put 50% on tariffs on Europe, and then by the end of the week, there weren’t.
So, these are very big and serious things. The market tends to overreact one way and then the other in the short-term, but it is fair to say that by the end of the quarter, people have thought that the bark is worse than the bite. Whereas at the start of the quarter, the evidence suggested the opposite.
Tom Merchant:
Fine. That’s great. And then I suppose it’s a very high-level, and I hope people appreciate with the intricacies of international relations, that I’d say predominantly drove a lot of the news cycle in the last quarter, that going too granular on any of these, for example, some of the conflict in the Middle East, I think it’s probably beyond the 20-minute market update from David and myself.
But if we try and maybe then focus back in on ourselves and what we did as a firm in terms of in the portfolios, appreciate that people looking at their valuations, probably like you said, see things relatively flower up over the quarter, despite all that noise. But can you talk a little bit around some of the changes you made throughout the quarter and then I suppose what we did to react to some of this?
David Cooke:
Sure. In general, what we try really hard to do is not react. It’s to pre-position in advance. And we basically did not do a lot during the quarter at all. We, “Didn’t react,” quote, unquote, because we were well positioned for this degree of uncertainty. We didn’t know that it was going to be as aggressive as it was, but we’ve always sought, strategically, a high degree of diversification across all asset classes, geographies and styles. And tactically, we also increased that in the months before this second quarter.
So we didn’t need to do a lot within the quarter, because in the end, this provided some resilience on the way down without taking risk off, so also you’re able to catch the bounce as well to some degree. And those themes are pretty straightforward. It really is a diversification game. So we have moved our equity exposures gently, which used to be US-dominated, into rest-of-world majority. That’s been taking place over the last nine months.
We have avoided the longer maturity end of the bond market because it’s very volatile. So we’ve moved the maturity profile, or duration, or sensitivity much shorter. And we’ve leaned heavily, where allowed in mandates, on the third leg of the big asset classes, so-called alternatives, because we can find a wide variety of strategies there that don’t mind volatility.
And if you put that blend together, then you’re able to ride out this volatility without getting in too much difficulty, which means you can keep your eyes open for any tactical opportunities. Not many arose, I have to say, in the second quarter, mainly because the fall and the rebound was so quick. It’s a matter of days, and it was just a little bit too quick to take advantage of some of the things that have been more egregiously sold on.
Tom Merchant:
Great. And then I think most people on the call, I suspect, are pretty familiar at least how we gain access to markets in the US. And obviously, it’s a very developed market, but when you say the rest of world, I think it might be helpful for some people to narrow down what that means. Is that emerging markets, is that all back into Europe? What does the rest of world look like for Saltus?
David Cooke:
Well, you just hit the highlights there. The major blocks outside of the United States are Europe and the UK, our home market, then there’s Asia, and then let’s call it the rest, which are categorised as emerging markets, but can be anything from giant economies like Brazil to smaller economies like the United Arab Emirates in the Middle East. And also, Japan as well as a standalone.
Our main rest of world positions are in Japan. That’s been long-standing for a while, because after 30 years of being in the doldrums, we now think they have a self-starting and sustaining story. There’s a lot of S’s in that last sentence. Glad I managed that one. We’ve also gone back to increase the European exposures, because the Germans have really aggressively upped to their spending profile and are using their balance sheet, and that will underpin the Euro and European assets.
And we have an emerging market focus that is higher, I’d suggest, than most of our peers. Mainly because a lot of those countries have got very idiosyncratic strong stories, and it gives us an extra degree of diversification that we think helps. Because, let’s say, a uranium miner in Kazakhstan kind of does his own thing independent of what the S&P 500 or the FTSE 100 does. So even within equities you can get quite a considerable degree of diversification benefit.
So you put all that together and that’s what the main things are outside of the US. And one final one, which I think is important to let clients know, is the UK exposures, both in equity and guilds. For many, many years, I’m talking at least 15, we had very, very small exposures, both the UK government and equity markets. Something closer to our 4% footprint in global indices, as opposed to the often 40% footprints you’d see in typical balanced portfolios.
And after 15 years plus of holding that, we’re reversing that position, and have been doing that for the last year or so. And that’s mainly because of valuation and catalysts. There is some money flowing back into the UK, either as a result of government reforms in the pensions market, or because a lot of people under the American administration have really sensed that, “Okay, if you want to rewire the global trading and security infrastructure, there’s a cost for that.” And the cost might be that people just don’t give the Americans as much capital in the past. And there’s some competition for new ideas and new areas, and the UK has got an investment case in the way that we haven’t had for 15 years. That’s what I mean by rest of world.
Tom Merchant:
That’s very helpful. And then you mentioned the reversal of our position in the UK, very difficult to point to an exact figure in terms percentage-wise, but we’re not going to end up sort of up at the 40% mark, or are we compared to our peer group?
David Cooke:
No, and I talk very much in aggregates of UK assets. So it’s risky assets, safe assets, special situations, some of which are some investment trusts, and it’s very much an evolutionary process rather than a revolutionary one. It’s not like we think the UK assets are going to go off to the races in a big way anytime soon, and we have to kind of pre-position to catch that.
It’s just that after 20 years-ish of derating and erosion, there comes a point when there’s basically an absence of selling, and the next marginal move will probably be buying. And it’s already happening in the corporate sector, where mergers and acquisitions activities picked up by number and value.
So the corporate sector realises there’s some good companies and good opportunities in the UK and it’s active. And I think that’s all you need, is just an absence of selling and a modest uptick in buying and you could have actually quite a good investment performance over the long run.
It’s also got one other thing, Tom, that’s worth mentioning, which is that a lot of these American policy issues are being played out in the foreign exchange arena, where people guess… If you want to express a view on America or the UK or Europe, you go to dollars and pounds and Euros first to express that view, and it’s very noisy and it’s very volatile there. One of the added benefits of maybe having a few more GBP assets is that we don’t have to then consider the extra risk of, will it a hedge that exposure overseas or not.
Tom Merchant:
Perfect. And then so obviously you mentioned the UK side of things and also the fact that everything we do tends to be gradual. So, in terms of most of this stuff’s been happening over nine plus months, but if we look ahead, I suppose both what do we see as the market prognosis for next quarter? So are we excited about it or are we cautiously optimistic? And then sort of second parts of that question, are we making any changes in the portfolios accordingly, or is it still much as muchness and the gradual changes at the moment?
David Cooke:
I think there’s no changes coming in the short-term, that’s because the short-term is noisy, but there are some long-term themes that we could take advantage of. So let me try and unpick that. Short-term is noisy because there are some positives. There are generally a world where interest rates are being cut and governments are spending, and that’s supportive, and soon the Americans might start accelerating down that path.
And also, the real economy, generally everywhere, appears to be quite robust, despite all this headline uncertainty that’s been around. So those things are supportive. And what they’re leading to is more positive sentiment, and there’s a bit of a momentum as well behind risk assets.
But the flip side of that is that prices are quite high. There aren’t any obviously brilliant short-term ideas to take advantage of, that the inflation impact of tariffs and the consequent impact on US interest rate policy, the cost of dollars is still unknown. There’s those rumblings, thunderstorms in the bond market which are not indications of health, and that could be destabilising.
So, it’s not clear what the brilliant ideas are on the short-term. So there’s probably nothing more to do over the summer. We shall see. We’ll take advantage of things if and when the arise. But over the longer term, that the trends are beginning to become clear, and we can start to play off them.
It now seems a strong emerging trend that the dollar, which is rich, is starting to be under pressure, that the pressure on government balance sheets, when they fund long is that it’s going to cost them more and more. So that doesn’t look like that’s going to lessen.
There are some pretty exciting trends around technology, the AI boom, which appears to be gaining traction more and more, particularly in the American economy that could yield some great earnings and productivity benefits. And then there’s the fact that there’s so much debt in the world that the financial system and markets just remain volatile.
So it’s going to be a lot of movement around these themes, even though you can see the themes emerging. There’s other ones such as energy transition and climate change and so on and so forth.
But what we can do is, as that becomes clearer, you can start to match those themes with asset values. And if there’s a cheap one or a mispriced one, then we can start to add it to portfolios. So that’s what we’re thinking. So we’ve got plenty to do over the long run, it’s just that you’ll see it happening in portfolios in the short run.
Tom Merchant:
Perfect. Brilliant. I think obviously delighted to have you join me today, and I appreciate we could probably go for hours if I drill down on any of these individual topics, but I hope people have enjoyed listening to you as much as I have, about a high-level view.
And as always, please do firstly revert to the website, to our insight section. The investment team are putting out lots of good information for our clients, as well as financial planning information in there as well.
And additionally, if anything is causing you concerns as clients, or you’d like further clarification, please do reach out to your advisers. We’re always delighted to speak to clients, of course. But I suppose from me, I’m just going to leave me to say thank you very much, David, for joining us.
David Cooke:
Pleasure
Tom Merchant:
Pleasure to meet with you as always. And please look out for the Q3 update later in the year. Well, hopefully I can persuade David to join us again. Thank you all.
David Cooke:
Thank you. Bye-bye
