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IPE special report May 2018

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Low returns to persist, challenge fund managers – Credit Suisse AM

The history of the “great crises of capitalism” suggests there is an “all too real” risk of the US Federal Reserve making a policy mistake like that of 1937, and that investors should expect low returns from bonds and equities for a decade or more, according to Jonathan Wilmot, head of macroeconomic research at Credit Suisse Asset Management.

Wilmot was speaking at an event in London to present the 2016 edition of the Credit Suisse Global Investment Returns Yearbook, to which he contributed a chapter on ‘When bonds aren’t bonds anymore’.

Wilmot outlined the market environment investors and the fund management industry could expect to face in the coming years on the basis of the previous “great crises of capitalism”.

These were in the 1890s, featuring a Latin American debt crisis, global panic and recession, and the 1930s Great Depression, according to Wilmot.

The third is the period from 2008, with the collapse of Lehman Brothers and the subsequent sovereign debt crisis.

Where we are now is “strangely familiar”, according to Wilmot.

The prevailing low bond yields in the major developed countries, for example, should not be a surprise given that the history of the other crises has shown that nominal bond yields keep falling throughout the subsequent recovery period.

For the next 7-10 years or perhaps longer, therefore, investors can expect zero real returns from developed market bonds and 4-6% from equities as “good working assumptions”, according to Wilmot.

A typical mixed portfolio of bonds and stocks will deliver 1-3% per annum, in comparison with the nearly 10% p.a. on offer over the past seven years, he said.

“That is a pretty challenging prospect for baby boomers and fund managers,” he told event attendees.

It makes very important the question of whether excess return can be achieved through active management, he added.

The “persistence of fragility” following major financial crises also raises the question of whether the Fed is making a policy mistake akin to that made by the central bank in 1937. 

In 1937, the Fed raised interest rates to stem an outflow of gold, precipitating what can also be seen as the second of back-to-back recessions at the time rather than one Great Depression, according to Wilmot.

“If we’re making a 1937-style mistake, it could be a big one,” he said, but he warned against expecting a “literal re-rerun”.

The persistent fragility of the economic and financial system, as well as investor and business confidence, are reasons to doubt whether December’s rate hike by the Fed is the beginning of a standard hiking cycle, he added.

Others are also sceptical about assuming more tightening from the Fed as a given.

Peter Hensman, global strategist at Newton Investment Management, said: “The US is as likely to restart stimulus as it is to raise rates through the year.

“I suggest the Fed should look at recent comments made by former Bank of England governor Mervyn King about what history now views as the Swedish central bank’s (Riksbank) error in raising rates in 2010-11 and then having to sharply reverse direction after inflation remained below its target.”

The Fed could make the same mistake, if it has not already, added Hensman, citing the instability of Chinese equity markets and the increasingly permanent “so-called ‘transitory’ declines in energy prices”.

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