Armstrong Investment Management yesterday (28 Sep) hosted a breakfast seminar at Brunswick Group’s London office entitled: “How to preserve and grow your wealth in an inflationary/stagflationary environment?”
In the opinion of the firm’s eponymous founders, Dr Ana Armstrong and Patrick Armstrong, cautious investors drawn to government bonds – which have seen yields tumble this year – are merely destroying the real value of their wealth. Mr Armstrong thinks inflation will be the most important issue for investors to deal with over the next decade.
“We’re negative on the USD, euro and sterling because we think the only way to tackle the debt problem in the West is through monetisation,” said Mr Armstrong. Monetisation has been in vogue the last 12 months as the US and UK grapple with gross debt which currently is equal to 100 per cent and 75 per cent of their GDPs respectively: printing money to pay back old debt. The natural consequence of doing this is inflation.
Armstrong IM expects UK inflation to average 4 per cent p.a. over the next decade: despite the Bank of England’s mandate to keep it below 3 per cent, the current CPI level is 4.5 per cent.
Dr Armstrong points out that investors will see a big devaluation in their portfolios and face “diminishing purchasing power” because of the debt situation. What’s worrying is that for the past decade Emerging Markets have helped suppress inflation in the West, but that’s changed this year. Western economies like the UK are flat lining yet inflation is rising because of commodity prices. As Dr Armstrong said: “We think China and other Emerging Markets will continue exporting inflation to the West. China is committed to curbing inflation which stands at 6.2 per cent but there are lots of pressures – wages there are rising 17 per cent p.a.”
Countries have three options for dealing with debt: they can either stimulate economic growth, monetise their way out, or simply default. Mr Armstrong believes the US will choose monetisation and isn’t overly critical of central banks choosing this option: indeed he thinks it’s the only option. But investors shouldn’t be confused that government bonds are somehow a good long-term play – they’re not.
“Debt becomes manageable if you engineer nominal growth. If you look at the US, China and Japan both own over 20 per cent of US treasuries. It’s because of this large foreign ownership that we believe the US will monetise its debt,” commented Mr Armstrong.
The Bank of England’s Mervyn King is talking down inflationary pressures, saying that they’re transitory. Interest rates have to stay low because the economy isn’t growing. Unemployment is rising. BOE is buying up GBP200billion of government bonds to keep yields low so what you have is a situation where inflation will help lower the debt:GDP ratio without any real economic growth occurring.
“We think the ECB will cut interest rates and the BOE will announce another round of QE this quarter,” said Mr Armstrong. Bloomberg quoted Frank Triolaire, head of inflation trading at BNP Paribas SA, London, as saying: “Everyone seems to be worried about a recession. The market is saying that it thinks the ECB should cut rates, and my view is that it should happen as early as next month.”
Interestingly, Dr Armstrong referred to a statistical study that highlighted just how much impact monetisation has on inflation in the US: “Money supply alone accounts for 50 per cent of inflation. For UKMS it’s even higher, around 60 per cent.”
As to where Armstrong IM is looking to make money in this inflationary environment, as said earlier it has a short allocation to the USD, JPY, GBP and EUR. The firm’s GBP220million IM Distinction Diversified Real Return Fund has long positions in the Singapore dollar, China yuan, Canada dollar and Korea won, each with an equal 1.5 per cent weighting.
The fixed income portion of the portfolio is focused on US short-term duration high yield bonds and global inflation-linked bonds, with Mr Armstrong confirming: “Any investor buying 10-year treasuries will find their purchasing power stripped away by inflation over the next decade.” He said the fund had a short-term tactical play – just 0.8 per cent – in Greek bonds and had made good returns earlier this year having shorted European banks as a hedge against the Greek bond position.
Equity stocks favoured by Armstrong IM include pharmaceuticals and utilities and a basket of consumer stocks including Louis Vuitton, Tiffany and Swatch “because these are price setters in an inflationary environment”, said Mr Armstrong.
Aside from buying Euro Stoxx 50 Dividend Futures on the expectation that equity dividends could, according to a consensus of opinion, climb from their current level of 125 to 170 by 2015, the firm is particularly bullish on agricultural commodities. With diets improving in Emerging Markets, meat consumption is rising. Mr Armstrong said that the fund had been long-biased on grains since 2005 and “is our preferred play right now”. Dr Armstrong’s research found that prices between grains and lean hogs were 87 per cent correlated. “We currently have a 6.5 per cent allocation in grains,” she said.
Inflation is firmly top-of-mind for Armstrong IM in its pursuit of capital appreciation through portfolio diversification – it could be a long battle if monetisation prevails. The fund is down 4.1 per cent YTD. It has returned 11.2 per cent since it launched January 2010.
