Magellan’s Hamish Douglass has warned that stock markets could face their most volatile period since the global financial crisis (GFC), saying US fiscal stimulus could encourage inflation and lead to higher-than-expected interest rates.
Douglass, Magellan’s chief executive and chief investment officer, warned that the US Federal Reserve and European Central Bank winding back their quantitative-easing programs has put investors in “uncharted waters.” He said it is unclear whether the major central banks will be able to gradually increase interest rates or whether they could be forced to tighten monetary policy faster than expected.
In Douglass’ view, the US Government offering a stimulus package of tax cuts and additional spending at the same time, at the top of an economic cycle, as such wind backs from the banks “may prove reckless.”
He was concerned that the size and timing of the stimulus could prompt a jump in US inflation. Stronger wages growth in particular could contribute to an increase.
“This may be highly problematic for the Federal Reserve and complicate its efforts to engineer a gradual tightening with a soft landing” of central banks winding back easing programs, Douglass said.
“We cannot think of a similar combination of circumstances in modern history. The cocktail could be explosive.”
Magellan felt that this combination could lead to risks that were asymmetrical to the downside over the next 12 months, as it was probable that US inflation and wages growth would accelerate, forcing the Federal Reserve to act both more quickly and extremely in tightening monetary policy.
Douglass said that swift and forceful action from the Federal Reserve could result in US longer-term bond yields jumping meaningfully. This could mean a jump above to 4 per cent, as opposed to 2.9 per cent for US 10-year Treasury bonds today.
This “could trigger the biggest slump on world share markets since the GFC. In our view, a 20 to 30 per cent global stock market correction is within the range of outcomes in these circumstances,” he cautioned.
In light of these risks, Magellan had increased the defensiveness of its Global Equity portfolio. This included increasing the cash weighting of the portfolio to approximately 13.5 per cent.
“It may turn out that we are wrong or premature to be so cautious,” Douglass said. “But we have no desire to remain at the party, nor be the last to leave, when we judge that risks are elevated.”
