In the 1980s I remember writing an economics homework essay about how the world was going to run out of oil by the year 2000 — Marion King Hubbert’s original ‘peak oil’ thesis. Well, predictions are tricky, especially about the future. However, the peak, and indeed trough, thesis seems particularly appropriate to the rather odd world we currently live in.

Peak stuff

Sure, we have had peak government and peak car but new terms are entering the lexicon: peak stuff, peak globalisation and even peak tech. We in the west, actually consume less stuff than we did ten years ago. My garage is full of stuff, which I have no need for even though ‘Aunt Amazon’ keeps knocking at the door (not sure my wife subscribes to the peak stuff philosophy). Most interesting is the significant weakness in global trade, which has been shrinking for a couple of years now —peak globalisation?[1] Maybe I am not the only one who wants nothing for Christmas; my wife says I’m miserable — I probably am.

Peaked or troughed?

It seems everything has peaked out or indeed the opposite; many seem to be going through a trough. Virtually every industry we can think of has too much capacity — airlines, shipping, steel, autos and retail — all with no pricing power. As seasoned readers will know we don’t lend to these industries; if it ‘flies, floats or rolls’ or indeed, if it is one of the three Rs, ‘retail, restaurant or the rag trade’. Take shipping for an example; it is an appalling industry, plagued by capacity build ups and no growth — witness the demise of South Korea’s Hanjin Shipping among others.

On a recent holiday to the Seychelles, I was amazed to read in the airport that there are 35 international flights a week into the Seychelles at an average capacity of 40% (breakeven load factor for airlines, the point at which operations start to make money, is currently around 60-65%). The Arab carriers, among many others, are throwing capacity at this route, increasing their market share and aiming to dominate it. Granted, this is good for cheap holidays as someone else is subsidising the costs.

Enter the ‘sharing’ economy

It was the Ikea executive, Steve Howard, who recently spoke about peak stuff; how it was unlikely they could sell any more furniture as everybody has enough already. This chimes a chord with us and seems hugely relevant to the shared economy. The average car only moves 4% of its life. So in the future we will need less cars and will simply be sharing them (arguably US car production is peaking out at the moment).

Airbnb could hugely lower the need for extra hotel rooms as we simply share existing houses; peak RevPAR (revenue per available room)? The effects could be hugely deflationary. Just look at the effect Uber is having on London private hire firm Addison Lee’s profitability, where they have recently fallen by two thirds.

So we can add to our list peak taxi fare, peak hotel room and peak car ownership.

Growth troughs, asset inflation peaks

Post the ‘Global Financial Crisis’, economic growth has been pitiful. Economic growth, inflation, defaults, volatility, productivity, trade, credit demand and bond yields all seem to have troughed while asset inflation peaks (S&P 500, NASDAQ indices) on an almost daily basis. There are a number of complementary theories to explain this.

Jenna and I have spoken about Richard Koo’s balance sheet recession view of the world for over five years now. This is where individuals or corporates do not want to borrow when interest rates are lowered, as they just want to reduce their debt — peak credit perhaps? Larry Summers’ secular stagnation is a similar view but emphasises excess savings as the cause of the lack of aggregate demand.

Demographics or deflationary effects of technology?

More recently demographics have been getting another airing — not enough producers/consumers and too many older savers — those dependency ratios just keep getting worse. Other theories focus on the chronic lack of productivity and the deflationary effects of technology and the shared economy. Witness peak technology; Apple handset sales have peaked as we are all saturated with mobile phone technology (do you know anyone without a smart phone?). Apple currently trades on a price over earnings (P/E) ratio of around 12.5 times, which would suggest it is not a growth company.

Behavioural changes matter

But more importantly, we think the behavioural change in the consumer is significant. My colleague, Arjun Bhandari, has highlighted the reduced desire and ability for millennials to consume as this demographic would rather purchase experiences than consumer durables.

Behaviours vary by generation but also by culture. We heard a story from a respected Japanese economist the other day — if you go to the consumer electronics district of Tokyo you will find canny Japanese consumers buying cheap ‘value’ Chinese made rice cookers. Whereas the ‘bling‘Chinese tourists tend to buy overpriced, over‑engineered Japanese rice cookers. It is not until we have a change in consuming behaviour, that we may have the remotest chance of getting out of the current economic malaise. Structural reforms, fiscal expansion and helicopters are all coming as well.

Did we mention ‘lower for even longer’?

We are sympathetic to all of the above theories. We have talked about ‘lower for even longer’ for years but now it is getting much more mainstream acceptance among our client base. In this regard, over the past year or so we have favoured quality, long‑dated (higher duration), large‑cap, non‑cyclical corporate bonds over high yield bonds. This has worked very well whereas some of our competitors are still in the reflation camp.

In a well-behaved world, business cycles follow the pattern of growth, boom, recession and recovery. In the boom phase excess demand leads to rising inflation, which in turn translates into higher interest rates to dampen the demand (hurting bond returns). The current prolonged period of recovery has naturally led to reflation theories. But such theories miss the important fact that the economy has now moved on from an excess in demand to an excess in supply, making the prospects of inflation even more remote.

Thus the current consensus that the boom in bonds is soon to go out with a bang, may actually turn out to be only a whimper. In reality, however, it is impossible to predict.

Meanwhile, in a little corner of the fixed income market…

The current economic environment has been a great time to be invested in corporate bonds. Central bank quantitative easing programmes, and more lately bond purchases by the European Central Bank and the Bank of England have made the bond drought even more severe. Peak bond maybe, but we are not convinced.

Remember, a golden rule of investing is ‘don’t fight the Fed’ and another is ‘respect the technicals’. Today’s bond markets are technical, technical and technical. If anything we prefer a more credit sensitive market, one that is more focused on the likelihood of company defaults and future earnings, but hey, who’s complaining?

We continue to like large reliable lower end investment grade and top end high yield corporate bonds, in our efforts to deliver a reliable income stream for our investors.

John Pattullo, Co-Manager with Jenna Barnard,
Henderson Diversified Income Ltd

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DISCLAIMER:

Before investing in an investment trust referred to in this article, you should satisfy yourself as to its suitability and the risks involved, you may wish to consult a financial adviser.

The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

Nothing in this article is intended to or should be construed as advice.  This article is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

Issued in the UK by Henderson Investment Funds Limited (reg. no. 2678531), incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3AE, is authorised and regulated by the Financial Conduct Authority to provide investment products and services.

[1] The tide of globalisation is turning, Martin Wolf, Financial Times, 6 September 2016

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