Photo: Moyan Brenn. Azimut Acquires 100% of AZ Global Portföy to Continue Its Growth Plans in Turkey
Azimut, Italy’s leading independent asset manager, has signed a binding sale and purchase agreement to acquire the remaining 40% stake in AZ Global Portföy Yönetimi A.Ş., becoming its exclusive shareholder. In addition, Azimut has agreed to sell its 10% equity stake in Global Menkul Değerler A.Ş. to the majority shareholder of GMD at market price.
On November 7th 2014, AZ Global was the first independent asset management company to be approved by Capital Markets Board to operate under the new regulatory framework enforced starting on July 2014. The new license sets a strong infrastructure for the Turkish asset management industry to deploy growth opportunities both in terms of production and distribution, enabling asset managers to directly establish and market, through proprietary sales force, their own products and services.
The transactions will enable Azimut to develop its plans in Turkey by investing in an integrated financial advisory platform comprised of its first local funds factory and distribution, AZ Global (to be renamed Azimut Portfoy Yonetimi A.S.), and AZ Notus, its discretionary portfolio management partnership.
Subject to the regulatory approval by the competent authorities, Azimut, through AZ International Holdings S.A., will recognise a total consideration (including the sale of GMD shares assuming current market prices) of around € 1.3mn.
Pietro Giuliani, Chairman and CEO of Azimut Holding, comments: “We continue believing in the potential of Turkey and the prospects of the local asset management industry, supported by a team of talented professionals and strong regulatory standards. Since our first JV in 2011, Azimut has developed an integrated platform which has achieved a 21% market share among independent players also thanks to the launch of two UCITS funds managed and advised by our Turkish colleagues. We are grateful to Global for the results we have achieved together and we will continue cooperating in the future.”
Capital Strategies Partners, a third party mutual fund distribution firm, holds the distribution of AZ Fund Management products in Latin America
Photo: Richard Masoner. Oil: Boon or Slippery Slope?
Are lower oil prices good or bad? Robert Spector, CFA, Institutional Portfolio Manager, Sanjay Natarajan, Institutional Equity Portfolio Manager, and Robert M. Hall, Institutional Fixed Income Portfolio Manager, from MFS, answer this question through a recent investment view.
In a year full of macro surprises, the sharp decline in the price of crude oil is the latest development to make headlines. Roughly one year ago, the consensus forecast for the end of 2014 was $100 per barrel for West Texas Intermediate and $110 for Brent crude — a miss of about 30% compared with current prices around $70. “As if on cue, many have been ready to describe how absolutely wonderful the oil price plunge can be for the global growth outlook”, highlights the report.
Winners and losers
To be sure, there are bound to be pockets of the global economy that will benefit from lower energy costs. When all the positives and negatives are balanced out, we can likely expect a net boost to global growth relative to what we would have seen with $100 oil. Then again, it was weak global growth —alongside oversupply— that was a key contributor to falling crude prices in the first place, so the argument becomes kind of circular, highlight MFS’ portfolio managers.
“We prefer to think of the oil price drop as stimulative overall, similar to a tax cut. Declines in the price of this or any other commodity help distribute growth away from regions that are producers toward those that are consumers. On balance, the net benefits to China, Europe, Japan and the United States could outweigh the hits to activity in Canada, Norway, Russia and above all the Organization of the Petroleum Exporting Countries (OPEC), where the erosion in terms of trade would impair domestic incomes, currencies, government revenues and capital spending plans”.
The drop in oil prices will put more downward pressure on already low global inflation, pushing some countries — namely, the United States and the United Kingdom — further away from their inflation targets and others — including the eurozone members — closer to mild deflation.
“Again, this acts in the same way as a tax cut to boost real consumer incomes. But when growth is weak and debt levels are high, any negative shock to nominal growth and persistently low inflation expectations could be bad for fiscal trends and rekindle concerns about debt sustain- ability — a potential risk for Europe”.
Implications for central banks
The impact of falling oil prices on inflation provides central bankers with yet more justification to keep the liquidity taps wide open. For the US Federal Reserve, which is expected to raise rates at some point next year, muted inflation pressures via lower oil prices tend to offset the effects of tightening labor markets. Should the Fed choose to postpone the anticipated rate hikes, this may be its excuse, states MFS.
The European Central Bank (ECB) will probably move toward outright sovereign bond purchases next year in its effort to fight deflation, while the Bank of Japan may maintain its easy money stance as inflation drifts away from its target. The combination of low inflation and slowing growth has already spurred the People’s Bank of China (PBOC) to take action with its first rate cut since 2012, with more likely to come if growth and inflation remain weak.
“In short, we would avoid becoming overly optimistic about the impact of falling oil prices on the global macro environment, as certain producing economies are likely to be hit pretty hard and the latest down-leg after OPEC’s decision not to cut output quotas could tip Europe into a mild deflation. Nevertheless, when the positives and negatives are netted out, and given other sources of stimulus already in place, there may be enough global growth in 2015 to support the valuations in risk assets“, concludes the report.
Photo: Andrew Gillan, Head of Asia (ex Japan) Equities at Henderson. Henderson Points to Lower Commodity Prices as a Big Positive for Asian Corporate Earnings in 2015
Andrew Gillan, Head of Asia (ex Japan) Equities at Henderson highlights in this interview risks and opportunities for 2015 in Asian markets.
What lessons have you learned from 2014?
It has been a year of divergence between individual markets within the region. This is partly politically-driven, with the change in leadership in India and Indonesia buoying those markets. But we have also seen other ASEAN (Association of Southeast Asian Nations) economies like the Philippines and Thailand perform well. Despite dollar strength, the traditional export economies of North Asia have not really benefited in terms of stock market performance despite relatively cheap valuations in China and Korea particularly. Volatility has increased through the year but Asian markets have held up relatively well following QE tapering, and the fall in commodity prices and oil should broadly benefit the region looking into next year.
Where do you see the most attractive opportunities within your asset class in 2015?
India remains one of the most positive markets but valuations also reflect that. We remain overweight as we still feel that the investments we have in financials, consumer, pharmaceutical and IT services can continue to generate significant profit growth and superior returns over the next few years.
What are the biggest risks?
Clearly the risk is that the economic reforms stall but the types of companies that we have exposure to have delivered impressive returns even in a weaker political environment. Our favoured holdings include both HDFC and affiliate HDFC Bank, Tata Motors, personal care, health care and food products group, Dabur, IT and outsourcing services group, Tech Mahindra, and pharmaceutical group, Lupin.
What is the highest position of the portfolio?
In absolute terms, China remains our highest country position at more than 20% of the portfolio and we have a mix of both new and old economy companies in addition to good consumer exposure. Despite the negative headlines and the reality of adjusting to a lower headline rate of growth – although importantly, better quality growth – valuations look attractive and company fundamentals are positive. There will be repercussions from the excessive loan growth of the last decade but I would also expect policy support to keep the economy on the right track. Favoured holdings include Baidu, which dominates the internet search market. This market continues to expand at an impressive rate, particularly from mobile communications, and the company is striking a good balance between investing for the future and profitability, as it monetises its market leadership position. In the consumer sector, we have exposure to auto companies, Brilliance (BMW’s joint venture partner) and Dongfeng Motor (partnerships include Nissan & Honda), which continue to offer good growth prospects and look attractively priced.
Are you more positive or negative now than you were 12 months ago on the economic and investment outlook? Why?
The regional index is broadly up in line with earnings growth for the year so that offers some comfort although we have seen stronger moves and consequently higher valuations in certain markets. In the short term, lower commodity prices should be positive for corporate earnings in Asia. Longer term, progress on reforms in the larger markets could provide a boost to equity markets and support the already positive macroeconomic investment case for Asia. Demographics, relative fiscal strength and a higher rate of growth ensure Asia looks favourable relative to other regions.
Photo: Tomwsulcer . Only 5% of RIAs Feel "Advanced" at Marketing or Business Development
Fidelity Institutional Wealth Services, a custodian for registered investment advisor (RIA) firms, has released findings from The 2014 Fidelity RIA Benchmarking Study,which revealed many firms recognize the need to improve when it comes to marketing and business development: only 5 percent feel their firms are advanced in these areas, and seven in 10 do not have a plan in place to guide them toward better business results, a number that has gone unchanged since 2011.
The study looks at what may be holding RIAs back from advancing their marketing and business development efforts and explores the best practices of “High-Performing Firms” to help RIAs learn from their peers.
According to the study, High-Performing Firms excel in the areas of growth, productivityand profitability. And while many factors can contribute to their success, these firms stand out in several important areas of marketing and business development: firm story, targeting clients, referrals and aligning talent—strategies that may be contributing to their ability to close business in two or fewer meetings and drive more incremental growth than other firms.
“Three-fourths of firms see improving their marketing and business development as a top strategic initiative, but they are struggling to make progress,” said David Canter, executive vice president and head of practice management and consulting, Fidelity Institutional Wealth Services. “As firm leaders sit down to think through their 2015 strategic plans, they should consider looking to their peers for insights on what is working and ideas on where to focus to make the most impact.”
Among the key findings of the study, High-Performing Firms are focused on telling a consistent firm story, while half of RIA firms are still struggling to establish one. Only 56 percent of all firms agree that they have a clearly defined and differentiated firm story, and only 43 percent agree their stories are tailored to the specific needs of target clients. High-Performing Firms are 1.7X times more likely to tell a consistent firm story, with all client and prospect- facing associates describing their firm and its key differentiators in the same way. As a result, High-Performing Firms are also more likely to agree that the majority of their clients know the fundamentals of their firm story, which can help clients become advocates for the firm.
While firms are making progress when it comes to targeting the right clients, High- Performing Firms are almost twice as likely to effectively communicate their target client profiles to help generate the right referrals. Firms with a target client profile reported that 90 percent of new clients added in 2013 fit this description, compared to only 75 percent of clients on board prior to 2013. High-Performing Firms are almost twice as likely to agree that they effectively describe their target client profiles to both clients and centers of influence (COI). This may help clients and COI identify the most appropriate referrals, which may lead to a higher percentage of clients fitting target client profiles over time.
Few firms have an “advanced” referral process; High-Performing Firms are four times as likely to leverage COI referrals to the fullest. Referrals from existing clients and centers of influence are important channels of growth for RIAs, accounting for 75 percent of all new clients. However, less than one-third of firms rate their referral processes as advanced, or even fairly strong. Only 14 percent agreed that they have analyzed their client base to focus on the clients most likely to make referrals. High- Performing Firms are 4X more likely to say their COI referral processes are advanced. This includes activities such as always thanking sources for referrals and working to understand their centers of influences’ target client profiles so they can send reciprocal referrals. In addition, they are more likely to review centers of influence data, such as referral status, at least monthly and keep data up to date.
High-Performing Firms have the talent and resources in place, while one-third of RIA firms are pursuing business development officers. High-Performing Firms are approximately twice as likely to be pursuing strategic initiatives to develop talent- management plans or change firm compensation plans—signs that they may be managing talent more proactively. They are also less likely to see lack of internal sales and marketing capabilities as an issue and, possibly as a result, are less likely to be hiring business development officers (81 percent not pursuing vs. 66 percent of other firms).
Photo: Dennis Jarvis. Russia Moves To Stabilize Its Currency
A sharp drop in the oil price has caused concerns over the potential damage to the Russian economy and has led the Russian central bank to raise official interest rates sharply to stabilize its currency. This Market Update sets out what is happening in the Russian markets, with comments from Fidelity Worldwide Investments.
Following international sanctions in protest at Russia’s expansionist policies in the Ukraine and most recently a sharp drop in the oil price, investors have become increasingly concerned about the potential damage this will have to the Russian economy as a major producer and exporter of oil. “We estimate that a 10% drop in oil prices can shave up to 1.3 percentage points off Russian GDP growth”, said the team of experts from Fidelity WI in an market analysis.
The Russian rouble has borne the brunt of these concerns (chart 2), depreciating dramatically against the US Dollar. Russian asset prices have also been falling across the board, with the stock market down over 8% in December, Russian 10 year government bond yields rising 5 percentage points to over 15% and 5 year Russian sovereign CDS rising from 318bp to over 620bp. The Central Bank of Russia (CBR) raised overnight interest rates by 1% less than a week ago but a further 10% slide in the currency yesterday prompted it to hike rates by another 6.5% to 17%.
“The CBR’s aim is to slow the depreciation of its currency rather than to achieve a reversal of direction per se. It is very concerned by the disorderly and dysfunctional way in which the currency has been trading. Rather than spend its foreign exchange reserves, which proved a costly and ineffective strategy in 2008, the CBR has decided to use the blunt tool of interest rate rises. Over the longer term, this should be effective in slowing an uncontrolled depreciation of the rouble by making it costly to sell the currency; however, in the short run the oil price is likely to be the most important determinant of the direction of the rouble”, explains Fidelity WI.
Could the Russian state be forced into defaulting on its debt, as it did in 1998?, ask the experts from the firm. “Overall, this seems unlikely. While there are some worrying parallels with 1998 when the oil price was also falling and Russia was also involved in an international conflict (an expensive campaign in Chechnya), the Russian government balance sheet today is much stronger than in 1998. General government debt is around 10% of GDP, whereas in 1998 it was 100%. The other main difference today is the CBR’s willingness to let the exchange rate float freely. As a result, unlike in 1998 a falling Rouble today can act as a shock absorber by balancing the dollar oil price falls and keeping fiscal balances stable”, they conclude.
Retail investors fell out of love with US bank loans this year, but demand from issuers of collateralized loan obligations (CLOs) has remained strong. New regulations may change that. Should investors be concerned? We think so.
First, a bit of background. In recent years, investors large and small have poured money into bank loans. Most were attracted by loans’ relatively high yields and their floating-rate coupons, which would provide insulation against an eventual rise in interest rates. At one point, loan mutual funds—a good gauge of retail demand—pulled in fresh money for 95 weeks in a row.
That streak ended earlier this year. Since then, retail investors have pulled money out of loans for 23 weeks running. At the margin, the reversal may have had something to do with concern about credit quality. As we’ve noted before, high demand for loans has allowed companies with fragile credit profiles to borrow on favorable terms without offering traditional protections to lenders.
But the bigger culprit, in our view, was changing interest-rate expectations. As it became clear the Federal Reserve would likely hold rates low for longer than many thought, it became less attractive to sacrifice the higher yields available on high-yield bonds for loans’ promise of floating income.
CLO Investors Play a Large Role in the Loan Market
A shift in demand as abrupt as the one loans experienced this year would normally cause considerable volatility. But the market weathered the change well. The reason? Issuers of CLOs—loans pooled together and issued with varying levels of risk and yield—have kept buying.
Now, new rules that require CLO issuers to retain a bigger slice of the loans they package and sell to investors may change that. The changes, part of the Dodd-Frank regulatory reforms, are meant to limit excessive risk-taking by ensuring that CLO managers have some skin in the game.
Instead, they may drive some CLO issuers out of the market. That’s because the risk retention rules make it more expensive for smaller players to create new funds. It’s unclear just how much this will affect demand. But the rule changes could sow the sort of volatility that the loan market managed to avoid when retail demand dried up.
While much was made of retail investor behavior in recent years, it’s clear that the leveraged loan market depends most heavily on CLO investors. As the Display shows, CLOs represented 44% of current leveraged-loan buyers through June. A change affecting nearly half the market is worth paying attention to.
Of course, CLO issuers won’t disappear overnight. The new rules were approved in October and won’t go into effect for two years. As such, next year might bring increased activity as CLOs rush to issue before the rules change. But over the longer run, we think things could get more complicated.
For one thing, it’s not clear who will step in to pick up the slack if CLO demand does taper off. Will retail investors come back? If not, will companies that have come to rely on the loan market for financing be forced to tap the bond market when their existing loans come due? Will bond investors play ball?
The answers to these questions are far from clear. It’s possible that investors will come up with creative ways to minimize the impact of the change. But in our view, the only thing that’s reasonably certain is that the leveraged loan market—and loan investors—face plenty of uncertainty.
As we’ve noted before, we think investors are already being undercompensated for the risk associated with bank loans. In our view, most of the perceived advantages of the asset class—high returns, floating rates, capital structure seniority—aren’t all they’re cracked up to be.
High-yield bank loans can be a part of a well-diversified fixed-income portfolio. But with so much uncertainty on the horizon, investors should be sure to weigh risk and reward carefully. In our view, a low-volatility high-yield strategy makes the most sense in the current environment.
Opinion column by Gershon M. Distenfeld, CFA, Head of High-Yield Debt Securities across dedicated and multisector fixed-income portfolios for AllianceBernstein.
. The Pacific Alliance and MILA: Forging a New Future for Latin America
The Pacific Alliance –an innovative and dynamic trade and investment initiative– is gathering strength in Latin America. The four-country alliance, established in 2011, represents a new generation in regional economic cooperation.
Observers in Latin America and other parts of the world may ask why this latest effort at integration and free trade will be any different from the past.
Their skepticism is justified. Earlier regional trade pacts –typically lacking a realistic economic foundation or a true commitment to change– have failed to prosper.
The Pacific Alliance –which currently includes Chile, Colombia, Mexico and Peru– is different. It represents a new breed of Latin American free trade agreements that seeks to achieve real economic integration and gradually move toward the free circulation of goods, services, capital and people among its members.
In contrast to other, inward-looking regional integration efforts, the Pacific Alliance looks outward and plans to use the economic and financial energy of its partners to develop new ties with the rest of the world, in particular the Asia-Pacific region.
The Pacific Alliance is built on a solid foundation. It is made up of like-minded governments that believe open markets and free trade are the way to promote economic growth and development. The members recognize that trading among themselves is simply not a formula for sustainable long-term growth. They want to attract foreign capital, not block it out.
This open philosophy is particularly important in view of weaker prices for raw materials, the economic slowdown in China and the urgent need for Latin America to boost exports of higher value-added manufactured goods.
The Pacific Alliance is already a significant economic force. It has a combined market of 212 million people and a GDP of over $2 trillion, accounting for 36% of Latin America’s total economic output and about half of the region’s exports.
Together, the four economies rank as the world’s eighth largest economic block. Moreover, their combined GDP growth outperforms the regional average, their growth outlook is positive and they attract more than 40% of the direct foreign investment that flows into the region.
Since creating the alliance three years ago, member states have made steady progress in meeting the group’s goals. The partners have lifted visa requirements for nationals traveling between the four nations, voted to eliminate tariffs on 92% of the products they trade and are moving to consolidate their diplomatic offices in some parts of the world.
In addition, two years before the alliance was founded, Chile, Peru and Colombia took a bold step and began integrating their stock markets. In 2009, they established MILA –the Integrated Latin American Market or Mercado Integrado Latinoamericano– which began operating in 2011. Mexico, the largest economy in the group, recently formalized its entry into MILA, signaling its commitment to the Pacific Alliance integration process.
This move offers huge potential for investors in the region and in other parts of the world.
Other neighbors are already knocking on the alliance’s door. Costa Rica and Panama are moving to join, and 30 other countries –including Canada and the U.S. – are observers. Canada, which has free trade agreements with all four alliance partners, would be a natural fit, especially because of its significant investments in the mining and energy sectors of these countries.
MILA – A magnet for regional and international capital
Private equity firms, such as Bricapital, see a bright future for MILA. The integration of stock markets represents a giant step for local companies, pension funds and other institutional investors, both domestic and international. It will give investors and enterprises alike a greater supply of liquidity, securities, issuers, increased diversification and much larger sources of funding.
With the inclusion of Mexico, MILA’s combined market capitalization will be an estimated $1.08 trillion, close to that of Brazil’s Bovespa stock exchange.
Market integration among the alliance’s four partners will offer significant new opportunities for local pension funds to diversify their investments.
Each of the member nations places strict limits of how much their pension funds can invest internationally. But with MILA, the idea currently being considered is that investments in any of the MILA countries will be treatedas domestic.
This means that promising businesses in these markets will soon have access to a much deeper investment pool. The pension funds in Chile, Peru, Mexico and Colombia represent a total capital pool of $455 billion.
A larger, pan-regional stock market will attract new investment, providing additional capital and liquidity and improved competitiveness and innovation. In addition, MILA is expected to boost asset values, provide investors with many more investment options and exit opportunities. Those things spell more jobs and regional economic development growth, as well.
At Bricapital, we believe that the Pacific Alliance and MILA are generating new and exciting investment opportunities for the region, and will offer Latin America a brighter and more prosperous future.
Opinion column by Yrene Tamayo, Managing Director and Executive VP of Bricapital
Photo: Roland zh. Vontobel Asset Management Sharpens Positioning to Achieve Further Global Growth
Vontobel Asset Management – which is currently part of Bank Vontobel AG – will be run as an independent legal entity and a wholly-owned subsidiary of Vontobel Holding AG in future. This strategic realignment is intended to form the basis for further growth in the global asset management market.
The creation of an independent legal entity is in line with Vontobel Asset Management’s strategy of operating internationally. The independence of asset managers is assigned high importance in most asset management markets and is a key selection criterion applied by international consultants and clients. This realignment underscores the international growth strategy pursued by Vontobel Asset Management, and this efficient and modern organizational structure takes account of global competition, says Vontobel.
The new company will operate under the name ‘Vontobel Asset Management AG’. The transformation of the business unit into an independent legal entity is subject to the approval of the Swiss Financial Market Supervisory Authority FINMA and the General Meeting of Shareholders of Bank Vontobel AG on April 29th, 2015.
The US central bank, the Federal Reserve, is the subject of criticism, no matter what it does. It has been roundly criticized for making money too easy and creating bubbles everywhere — in short, that its actions aren’t working. If its actions are working, then the talk is that this artificial support will have to be removed, and the Fed will trigger a market collapse by doing less.
I suspect, however, that the easy money accusation against the Fed —and the implication that stock prices have to fall without its efforts to keep rates low— may be erroneous. Here are my reasons:
Low rates and signaling
Now that its unusual program of bond buying known as quantitative easing has ended, the Fed is hinting that it will set out to slowly raise interest rates in 2015. By any comparison with previous cycles, rates are low and real rates, or stated government bond yields minus inflation, are abnormally low, especially when contrasted with the story of better growth in the US economy.
The Fed has already signaled its intention to let rates rise, and the equity market has continued to go up. Increases in interest rates, particularly those induced by the Fed, have historically been greeted by a rising, not falling, stock market. Why? Because such actions by the US central bank tend to occur in the face of expanding economic activity and the stock market welcomes sustainable growth. Also, price-to-earnings ratios often rise, not fall, in the face of protracted rate increases.
Debt and interest expense
The net debt held on the balance sheets of companies in the S&P 500 Index is much lower relative to their cash flow than we observed in the past three cyclical peaks. Therefore, a rise in rates won’t have the same negative impact on profits as in previous cycles. And the share of debt whose interest expense has been fixed is now at historical highs: 88% of the net debt of the S&P 500 is fixed with the issuance of public bonds, not at the mercy of flexible-rate bank loans. The high share of fixed-rate debt will also tend to cushion any shocks from rising rates.
Furthermore, US consumers — who buy most of the consumer goods and services produced by publicly traded companies — have far less debt relative to their disposable income than in other cycles. Thus, they won’t have to pull back spending that much to pay for higher debt service burdens.
Supply and demand imbalance
The world may be awash in government debt of all sorts, but it is also awash in savings and accounts that seek safety. Massive reserves have piled up in emerging markets, exporting countries and pension funds. These huge storehouses of money — accounting for about 28% of global GDP — reside mostly in US dollars and pursue primarily AAA-rated debt to purchase.
Yet the supply of triple-A debt has been dwindling as more countries receive lower ratings from credit agencies. And the United States, the world’s biggest supplier of new debt, has experienced smaller government deficits and so has less need to borrow. With the supply of good bonds shrinking while the demand for them rises, this imbalance tends to work in favor of higher bond prices and lower yields, which also puts a limit on how high US rates will go when the market, not the central bank, is determining rates.
Concluding thoughts
My first conclusion is that if the equity market was vulnerable to collapse from the Fed’s actions to taper this year and tighten next year, we would already have seen it by now. After all, the markets try to anticipate what is coming next. Fed rate increases should come as no surprise to investors who have known for years that rates haven’t been at the equilibrium levels that the markets would set.
Second, there is little support for the claim that the stock market is a bubble. Many valuation measures suggest the market is in fair value, not peak price, range. Third, inflation around the world is subdued or falling, further curbing the upward rise of interest rates.
Finally, the impressive profit performance of S&P 500 companies late in 2014 shows no signs of abating. I believe the evidence is piling up that the forward momentum of the US economy can support higher profits and higher rates.
Photo: Seattle Municipal Archives. Why are Americans so Pessimistic about the U.S. Economy?
Five years after the Great Financial Crisis (GFC), despite improvements in GDP growth and employment, the U.S. public still seems to be oppressed by a cloud of negative sentiment. A recent PewResearch Survey found that a majority of Americans still perceive the economic climate as poor or fair at best (83%), a level still far below pre-crisis sentiment. Mike Temple, portfolio manager of the Pioneer Dynamic Credit Fund, explains the reasons for this pessimism.
In the eyes of many, a freight train of seemingly unsolvable problems –cost and quality of education, income disparity and structural unemployment– is leading to an accelerating decline of the U.S. and a possible near-term repeat of the GFC that ravaged investor portfolios. “We don’t deny that many daunting challenges lie ahead. But dynamic, longer-term trends are opening up entirely new avenues of invention and industry, which could potentially usher in an era of stunning growth and prosperity. We are optimists and think it is time to step back from the fear and uncertainty that currently characterizes the public mood and explore these trends, their impact on the economy and their implications for investors”, said Temple.
The Root of The Problem: What Happened to the Jobs?
“We believe much of the pessimism is rooted in the challenges that the labor sector is facing. The chart below provides evidence that the rate of recovery in employment, in the last two recessions, has slowed dramatically, which has led to a national debate as to whether the rise in unemployment is structural (permanent) or merely cyclical”, affirm the portfolio manager.
The Federal Reserve believes that the U.S. unemployment story remains largely cyclical (translation: all we need is a robust recovery). Some distinguished voices suggest that we have entered an era of “stagnation” and need to lower our expectations, said Temple, believing the employment challenge is evidence of an economic malaise brought on by an era of diminishing innovation and demographic headwinds. “While we agree with the Stagnation argument that the demographic tailwind of the Baby Boom era is behind us, we are convinced that the longer-term employment problem is linked to the technological replacement of human workers“, says Pioneer Investments research.
The Weak Employment Cycle Began a Long Time Ago
The weak employment cycle began a long time ago with the deceleration of the labor force growth driven by secular trends, which is the foundation of the Stagnationist argument – demographics, including retiring baby boomers, female labor and immigration.
The “participation rate” (the share of the working-age population that is actually in the labor market) has been on the decline since 2000 as more people retire and leave the workforce. However, it is the younger population and the most productive sector of the workforce (25-54 year olds) that is the key driver. This segment should be the most resilient to cyclical and demographic trends, but it has clearly suffered a setback.
From Geographical Outsourcing to Technological Outsourcing
Growing competition from China is one reason for structural weakness in the U.S. job markets, explain Temple. Relocation of manufacturing to areas of the world, where labor was dramatically cheaper resulted in a loss of jobs in the U.S. Despite losing 7 million manufacturing jobs over three decades and manufacturing declining as a percentage of GDP (currently 13%, down from high teens in 1990’s), the absolute size of manufacturing output still grew. Other major sectors such as Construction, Mining, and Information have also experienced a broad decline since the beginning of the 21st century.
“Yet over this time frame, the economy has continued to grow. What gives? We believe that the geographical labor arbitrage that took place in the manufacturing sector over the past 25 years masked a wider phenomenon of technological labor arbitrage. And it is technological arbitrage – which we will examine in our next blog – that will dramatically shape th U.S. economy in the coming decade”, concludes Temple.
