Bond bubbles, asset flows and changing times; three trends for long-term investors to watch out for

How might consumer behaviour change as a result of the crisis, and which areas of the market will be the beneficiaries? Are these developments – e.g. the growth of online retailing – already priced in?

There are two key aspects to think about here, the first is the amount of consumption, and the second is how consumers spend. The former is key to determining the length of the recovery; in times of economic stress consumers will stop spending and start saving, and so far this has been the case across most countries. If that persists, and if companies start decreasing investment, then the recovery will be muted. The optimistic view, which is currently reflected in market prices, is that the pent-up demand will lead to a quick bounce back in consumer spending. Our view is more cautious; yes, we may see a pickup in spending, but not all consumption will made up for, some will be lost for example consumers won’t be able to make up all the restaurant expenditure they forewent during lockdown the moment it eases.

On composition, people tend to overestimate the short-term changes of consumer behaviour and underestimate the longer-term impacts. We’ve seen the share price of video conferencing companies take off, but there are long term trends in areas that are under researched and have further to go. For example, the rise of home working could lead to people moving out of city centres, leading to a potential boost in durables for building houses. Similarly, secular trends such as online shopping and telemedicine have been accelerated by the crisis, and while these trends are well understood, there are still pockets of growth potential for the long-term investor.

Looking to the behaviour of market participants, we’ve been talking this week about the differences between retail and institutional flows, could you expand on these? How do the trends inherent in these flows compare to our own recent investment activity?

To summarise; Warren Buffet hasn’t been buying but Robin Hood has been picking his pockets. Robin Hood is a new online brokerage house for with zero commissions, which investors can use to analyse retail asset flows. Not only has there been a surge in new accounts, but buying activity increased significantly in March, as indeed it has across other large retail brokerages.

There is evidence to suggest that with more time at home or out of work, consumers have taken to day trading. Indeed, the second highest expenditure from a stimulus cheque for middle incomers in the states was into stocks and shares saving accounts. We’ve seen a slightly different story from the mutual fund market, where we’ve seen net outflows from equity funds, so overall the data is mixed, but it remains a worrying sign that the “buy the dip” mentality is so engrained.

Institutional investors have been more cautious, fund manager surveys show that the majority are expecting a u-shaped recovery and believe that we are in a bear market rally.

On our side, we went into this crisis with defensive positioning, so we have added some risk by selectively buying value and quality names, but we mostly remain cautious of the risks of overvaluation and reliance on policy to support asset prices.

US companies have released over trillion dollars’ worth of bonds this year, should investors be concerned by these corporate debt levels? Are there comparisons to be drawn with the credit bubble leading up to 2008?

This is a key problem for long term investors. We have seen corporate debt grow faster than GDP since the crisis, and while that has been a great tailwind for corporates, there will be a deleveraging phase. There is certainly a comparison to be made with 2008, but a key difference is that what we had then was a build up of household debt, and balance sheet recessions take longer to recover from as consumers are reluctant or unable to boost the economy by spending.

The risks inherent in corporate debt burdens are different. Companies have been using debt – around a trillion dollars or more – not to invest in growth but to buy back their own shares. Indeed, the biggest buyers of US equities in recent years has been US companies themselves. Large US companies now do have large cash piles on their balance sheets, but there is a lot of vulnerability in the companies that have over-levered. Left to its own devices this could have been very dangerous, but the US Fed’s actions have done a lot to help corporates weather the storm in the short term, although the longer term problem remains.

In the short term we are likely to see pockets of pressure develop as a result of the debt burden, there are already warning signs in the leveraged loan market, and there will be defaults in the lower quality names. But bigger problems lie in the long term; the overhang of debt will depress growth, and the solutions it requires carry their own risks, including inflation, financial repression, higher taxes and keeping interest rates low. Being conscious of these risks will be a crucial way for asset allocators to differentiate going forward.

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