Global investment manager Brandywine believes economic pessimists have gone too far with their dire predictions, but it still sees many challenges ahead both in Australia and elsewhere.
With the commodities boom having reached its apex, there is little upside left in the Australian dollar, according to Francis Scotland, the director of Global Macro Research at Legg Mason subsidiary, Brandywine Global.
Discussing developing global market conditions with Money Management in Philadelphia last week, Scotland said Brandywine’s view was that the Australian dollar was extremely expensive by historical standards and that the only thing propping it up was commodity prices.
“To the extent that we believe that you’ve seen the peak of the ‘commodity complex’, my personal view is that there is no more up-side in the Australian dollar,” he said.
“The only question in my mind is what sort of trajectory it takes lower.
“Will it be a slow trajectory? Does it stay in a trading range for a while? Does it revert back? Our calculations on the Australian dollar place it at around US85 cents, so it is currently a long way from some sort of sustainable equilibrium,” Scotland said.
However, Scotland pointed to the fact that Australia was one of the few places where investors could still obtain a positive real return in the bond market, which suggested a case could be made for maintaining a position in Australia while hedging the currency.
In fact, these were precisely the settings that Brandywine Global was applying to the Australian market.
At the same time, Scotland said Brandywine had rotated its global portfolio exposures into a number of emerging markets such as Mexico, Brazil, Hungary, South Africa, Korea and Malaysia, albeit the company might not still be there in six months’ time, depending on how events unfolded.
“It’s much more of a ‘rifle shot’ strategy than has been the case over the past two or three years when everything was painted by the same brush,” he said.
“So looking at these countries on their own merits suggests there’s a good case for yield compression and ‘safe haven’ bond markets where we think there’s over-valuation.”
Scotland said it was very much a case by case strategy with respect to both bonds and currency.
Containing credit growth
While Brandywine Global is generally upbeat about the prospects for global economic recovery, Scotland believes the absence of credit in the equation will make it a prolonged process.
Pointing to the fact that bank credit growth remains at levels not seen since the Great Depression, he said.
“This is one of the weakest periods of credit growth in US economic history, so we have not had that tail wind,” he said.
“And when you think about asset price inflation, I always think about the root of any inflation as credit growth in excess of gross domestic product.”
Scotland suggested that on such a basis it had to be considered where the money was actually going to go; whether into food prices, housing or stocks.
However, he said this had not been the case since 2008 and that the base case for asset price inflation simply did not exist in either the US or Europe, and more recently, it had appeared to stop in China.
Scotland said he personally believed that the absence of credit growth represented a good thing for the long haul.
While there were countries where asset price inflation would continue to exist, it was now by and large absent from the market.
Economic pessimism overblown
Looking at how the global investment environment would evolve over the next six months, Scotland said something that stood Brandywine apart was the “pragmatic” approach it took to investment.
“Rather than get wedded to a particular view about how the world is going to play out, we focus on a combination of ‘price risk’ and ‘information risk’,” he said.
“So the idea is we look for pricing anomalies – things that are going on in the world where the price of a bond, a share or a commodity seem to be trading at level that is deeply discounted or at an extreme.”
Scotland said Brandywine’s view of the global economy is that it is going to turn out better than what is currently being priced in.
However, he said the company’s analysis should not be confused with it holding a ‘bullish outlook’, but rather, that it had concluded that some of the dire predictions for the market which had prevailed two or three months ago had been excessive and that there would be the necessary policy reactions to deal with those problems.
That policy reaction had been the European Central Bank efforts in dealing with the Eurodebt issue.
“What I think will be one of the big changes in the environment not only over the next six months but over the next 12 months is what I call ‘the end of the era, risk on, risk off’,” Scotland said.
“If you think about how events have played out over the last three or four years, in 2008 we had the financial crisis and the theme was survival, in 2009/10 we had a huge policy response and the theme was reflation.
“So in 2008 risk assets went down, and with the policy reflation in 2009 we had the reflation of risk assets which up in unison in 2010, while in 2011 the authorities started to tap on the brakes, with the ECB raising interest rates and the US Federal Reserve suspending quantitative easing 2, and so we had a shake-out in the second half of 2011.
“With 2012 we’re stepping up the stimulus again, and you can see the game change in Europe and the Chinese turn the policy dials more aggressively, while in the US we have the ongoing commitment of the Federal Reserve to sustain monetary accommodations,” Scotland said.
