PSigma income manager Bill Mott believes we are in “the biggest financial experiment in history” as the global economy continues to walk a tightrope.
Mott (pictured) says the measures being taken by authorities in the wake of the financial crisis, such as the low interest rates across the globe, efforts to shore up the eurozone and quantitative easing programmes, present a high risk of a black swan event.
He says: “There is no doubt this is the biggest financial experiment of all time. At the moment, it is a bit like pulling at a brick with a piece of elastic. You can pull it a few times and nothing happens and then all of a sudden either the plastic snaps and the brick is marooned, like the Japan scenario with deflation, or suddenly the brick will fly through the air and smack you in the teeth.”
Mott believes there is a 60 per cent chance that the UK economy will continue to walk the tightrope and his portfolio is positioned for “a grinding, low-growth scenario, where there is neither a recession nor a boom”. Mott says that scenario would see the UK economy grow between 0.5 and 1.5 per cent a year.
Mott says the deflation scenario in his brick analogy has a 15 per cent likelihood of happening while inflation has a 25 per cent chance of occurring.
He believes the problem authorities face is the impact of quantitative easing and the austerity measures in Europe. He says: “It is almost impossible to know the breakout velocity the brick will need or the torque the elastic will need before it snaps.
“These things involve the psychology of the populace, which constantly changes. We are also in an environment where savers are being screwed to help borrowers, so unusual things are occurring.”
Mott believes once inflation falls below 2 per cent, the Bank of England will need to normalise bank rate.
He says: “It is my contention that if inflation falls and the squeeze on real disposable income lessens, the BoE should normalise interest rates. If it does not and global growth occurs, oil, food and other commodities will act almost as a central bank, their own prices rising and squeezing real disposable income, pushing inflation up again. I do not think the bank will raise rates and that will be a policy error.
“Politicians and central banks are more scared of deflation than inflation and are likely to end up erring on having too loose a monetary policy for too long.”
Inflation has fallen rapidly from a peak of 5.2 per cent in September 2011 to 3.4 per cent in February. Last month, BoE chief economist Spencer Dale said he expects UK inflation to hit its 2 per cent target by the end of 2012.
It is widely predicted the bank will not raise interest rates until 2014.
Mott’s £450m fund was five years old last week. It is currently top-quartile in the IMA UK equity income sector in the past 12 months but third-quartile over three years.
Mott says to succeed in the current environment, he has relied upon companies that are high-yielding, economically insensitive and cashflow-generative. This has resulted in 90 per cent of the fund being exposed to large-cap stocks - a position he says is unlikely to change any time soon.
Mott says: “We have big pharmaceutical positions, as well as a strong exposure to utilities, tobacco, food and consumer staples.
“These companies should be successful in all three scenarios. My fund will be successful in the tightrope scenario or if a slump favouring defensive companies takes place.
“If the deflationary scenario occurs, our exposure to oil would reduce but there would still be geopolitical risk in doing that. If we saw more inflation, we would introduce a greater exposure to oil as well as to food companies.”
Advisers have previously raised concerns that the chase for yield has resulted in many income portfolios mirroring each other.
Mott says: “The difference between us and other equity income funds is that we are barbelling against a significant position in oil - about 19 per cent of the portfolio. Most fund managers in my view are either risk-on, and have oil with other risk-on-type equities, or if they are risk-off they will also be risk-off oil. We are unique in having an overall defensive portfolio but barbelled against a strong weighting in oil.”
Mott says markets are currently at the peak of a 10 per cent trading range and may start to creep lower, purely on a lack of interest.
He says: “Markets are sideways and boring but sideways is good for the likes of Vodafone and GlaxoSmithKline, which are yielding well in excess of double what you can get from 10-year government bonds.”
With a 9 per cent weighting in financials across four stocks, Mott is not the biggest fan of the sector.
He says: “The long-term refinancing operation has solved problems in the short term but not the longer term. Authorities hope when we get to the end of the long-term refinancing operation, the austerity mix will give people more comfort on the eurozone. If they fail, they can always do more but they cannot keep kicking the can down the road.
“Financials do look challenged in the long term in the new business environment. Banks’ profitability looks pretty opaque and there is a lot of directional investment, such as banks being forced to buy Government bonds.”
Mott has talked about financial Armageddon in the past and says although this has calmed, it could still happen.
He says: “The chances of Armageddon are as high as the chances of a euphoric period for global economic growth, like we saw between 2003 and 2007.”
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14 Sep 2010 | Updated: 14 Sep 2010 10:04 am