Asset Allocator's Soapbox: Apollo's Tom McGrath

Apollo’s Tom McGrath on how to deal with choppy waters over the coming months.

Back in 2002, when the word deflation began appearing in the business news, Ben Bernanke gave a speech about deflation. In that speech, he mentioned that the government in a ‘fiat money’ system owns the physical means of creating money. He said the US government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at no cost.

He added that these could, in theory, be dropped by helicopter onto the people below to kick start the economy. Given the fact that growth indicators in the US are now rolling over, with new house construction falling, unemployment rising, retail sales and factory orders tumbling, we think it is time for Helicopter Ben to restart the printing press and get his Chopper out!

Double-dip recessions are few and far between, and you have to go back to the early 1980s to find the last one in the US. Ben B’s helicopter threat in 2002 was not needed, because at that stage the Fed had the room to bring rates lower. That luxury is no longer present with existing rates already so low.

So, in our opinion, fiscal stimulation is the only way out if growth continues to slow. Given the financial austerity measures, Europe is also in no position to help global growth without significant short-term QE, and we do envisage the ECB and the Bank of England will re-engage this policy. Indeed, there are even signals that the Chinese Central Bank is starting to ease back on tightening.

Despite the woes of the Anglo Saxon world, the good news is that the world economy is not going to ‘double dip’. We do believe that Helicopter Ben will be fast to act if growth continues to disappoint.

But, more important, Asia will continue to grow. The demographics and urbanisation guarantee a rapid growth in consumption and a liquid and functioning banking system can, and will, deliver the credit to enable this growth in domestic demand.

In addition, in Japan, at a corporate level we have a strong sense that the economy’s export driven recovery is alive and well and with valuations now compelling we are tempted to use the recent sell-off to top up positions modestly.

Although we began this update by highlighting the short-term threat of deflation, we think we know the unspoken end game, which must surely mean a liquidity super-cycle that is necessary to inflate away the over accumulation of western debt.

Such a cycle would underpin an aggressive ‘risk on’ phase that would see emerging markets and commodities making strong profits and bonds being sold off heavily. As multi-asset investors, our job is to try to time the tectonic shift between deflation and inflation, giving due consideration to the fact that markets look forward.

Perversely, the weaker the economic data, the more likely QE will start again, which could be the catalyst for ‘risk on’ and the next leg of this bull market to start.

We certainly could be wrong about the increasing economic weakness in the US, UK and Europe, but our greatest fear is that the authorities fail to act in time and delay QE. If it came too late, there is always the danger that even dumping money from a helicopter would fail to get people to spend.

We foresee choppy markets for the next few months and we are letting cash drift up in the funds. If things continue to deteriorate and there is no QE forthcoming we could see equity markets break to the downside.

Conversely, if the US, ECB and China put the foot down again, expect a liquidity fuelled rally.