(Apr 8): Jean-Louis Nakamura, Asia-Pacific chief investment officer and Hong Kong CEO for Lombard Odier, a Swiss private bank that was founded more than two centuries ago, does not expect the aggressively loose monetary policy implemented in the wake of the global financial crisis to ever be completely reversed. “Quantitative easing is here to stay forever,” he says. “It is a normal tool for central banks.”
And, he was surprised at the US Federal Reserve’s apparent hurry last year to normalise its monetary policy by hiking rates four times while shrinking its balance sheet, despite the absence of inflation and increasingly negative signals from the market. “At the start of last year, we did not expect the Fed to hike four times,” he says. “When we saw it was going to hike interest rates, we did consider it was, potentially, a strong policy mistake.”
Nakamura spoke to The Edge Singapore on the sidelines of the bank’s Rethink Investments Summit Asia, which attracted some 300 clients, prospective clients and partners from around the region and provided insights into some of the key political and economic forces shaping the region today.
Not least among these is the sharp turn in the Fed’s stance in the last few months. It was only in October last year that Fed chairman Jerome Powell had said that “we are a long way from neutral”. Then, in December, in a widely reported speech at The Economic Club of New York, Powell said that interest rates “remain just below the broad range of estimates of the level that would be neutral for the economy”, which spurred global markets. Since then, the Fed’s statements have only become more dovish, and US bond yields have continued tumbling. Ten-year US Treasury bonds are now trading at yields of 2.52%, versus more than 3.25% in October last year.
The way Nakamura sees it, monetary policy ought to be flexible at the late stage of a business cycle. “[It] is the stage of a business cycle where labour markets are tighter, [and] wages start to accelerate a little bit,” he says. “Demand is decelerating. So, companies’ profitability is at the risk of being squeezed.” Yet, conventional thinking is that central banks ought to tighten monetary policy at the late stage of a business cycle to stave off the inflationary pressure of rising wages on the back of low unemployment. “Policymakers are obsessed with the risk of inflation, even when there is no inflation. They tend to increase interest rates ahead of actual inflation. Real rates [then] increase and business cycles terminate prematurely.”
In fact, inflation has not been much of a problem in the last few decades. Consequently, successive peaks in interest rates have declined too. The result is that the excesses of recent economic cycles were not completely washed out. According to Nakamura, each recession over the last 50 years ended with debt at higher and higher levels. “This is also why each recovery for the last 30 years has been weaker and weaker, both in nominal and real terms,” he says.
So, why has inflation declined in recent decades? Nakamura says it probably has to do with increasing automation and widespread use of technology, which has made it harder for workers to demand higher wages. “That is probably one of the reasons why wage acceleration at the end of a business cycle, even when the labour market seems to be tight … [is] not that much today in comparison to the past. Today, wages, on a y-o-y basis, in the US, is 3%. At the end of a business cycle 10 years ago, it was 5%.”
Consequently, we are no longer living in a world where consumer demand is funded by wage growth but by borrowings and the wealth effect created by rising asset prices, according to Nakamura. “When companies, investors and consumers feel wealthier because asset prices are going up, they tend to consume more. And, they have an even easier access to credit. So, it’s kind of a vicious cycle.” In effect, asset prices are not so much driven by underlying economic growth but a driver of economic growth. “So, if you want economic growth to persist and be maintained, you need to permanently inflate the price of financial assets [and] property.”
Nakamura acknowledges that many market watchers might view such growth as ultimately unsustainable. But he views it as a set of circumstances that central bankers as well as investors simply have to live with. “You might look at this in a bit of a cynical way,” he says. “But there is no real alternative, because today we don’t have the capacity anymore to clear the excesses of the past,” he adds. “The role of policymakers, especially in central banks, is no longer to fight against the risk of inflation. It is more to prevent volatility from rising and asset prices from collapsing.”
So, where are the markets headed now? Where are the opportunities after the sharp rebound from the lows of the final months of last year?
Positive on credits, equities
Nakamura says Lombard Odier advises its clients to maintain a “core” portfolio that is diversified not just in terms of asset classes but also in terms of key macro risks. In essence, Lombard Odier measures the risks across a range of asset classes, and adjusts the holdings of its clients’ core portfolio to balance these risks. The strategy does not always produce outperformance, though. “Last year, the best thing to do was not to be diversified but to be invested in the US tech stocks,” Nakamura says.
However, Lombard Odier stuck to its strategy, and loaded up on long-dated bonds, he adds. “From the end of August to December last year, we increased our exposure to long-dated bonds from 30% to 50% in our portfolio — which is a huge move. The market was telling us that if you want to balance your risks, you need to have... less and less equity risk.” That served the bank’s clients well over the last few months as bond yields sank dramatically.
Based on its assessment of market risks, the bank is now moving its clients’ core portfolios away from bonds in favour of credits and equities. In the credit space, it sees particular opportunity in US dollar-denominated Asian credits, a market that is growing fast. Nakamura adds that US dollar-denominated Asian credits have the advantage of providing exposure of sorts to the US Treasury yield curve. “So, in case things turn bad, at least you will be partly protected. Of course, your spread will widen, but long-term US Treasury yields will collapse,” he says.
“Local currency emerging bonds are interesting, but you need to make a bet that the US dollar will depreciate — which, in our view, is probably the best outcome for the global economy,” he continues. “We need this depreciation of the US dollar, especially in emerging economies, in order for that late cycle to be extended for some time. Without that depreciation, it will become more and more difficult.”
On equities, Lombard Odier’s risk assessment models are pointing towards higher exposure to emerging-market equities at the expense of developed-market equities. “We are almost as much in emerging-market stocks as we are in developed-market stocks. And in emerging — we like Asia especially.” Nakamura says China could well be among the first of the world’s largest economies to stabilise, largely because it was the first to begin pursuing reflation policies. “Then, Europe will breathe again because of the stabilisation of China,” he predicts. “Germany’s manufacturing exporters are very sensitive to China’s demand. Finally, the US will benefit from both situations.”
Assuming that the US dollar does not suddenly appreciate again — or better yet, that it depreciates — the months ahead could be positive for Asian markets, according to Nakamura. “Asian economies, which are very sensitive to the devaluation of the US dollar, might do very well again,” he says. “This explains the rebound in Chinese and Asian stocks [since the beginning of this year]. We believe that there is a significant way for them to outperform strongly going forward.”
Bullshit jobs?
Returning to the question of why technology appears to be weighing down rather than enhancing productivity and growth, Nakamura points out the advent of the smartphone certainly has not had the impact many people might have expected. “The first iPhone was received in 2007. If you look at the global economic growth over 10 years prior to 2007, the average was 2.6%. If you look at the global economic growth for the 10 years after the introduction of the iPhone, it was 1.3%,” he says.
To be sure, the period following 2007 was affected by the global financial crisis of 2008. But the period prior to 2007 had its share of volatility too, including the Asian financial crisis of 1998 and technology bust in 2000. “So, it’s true that the more we innovate, the weaker and weaker productivity seems to be,” says Nakamura, who started his career as an economist at France’s Ministry of Finance, rising to become CEO of the French Civil Service Pension Fund.
Besides technology itself weighing on the ability of workers to demand higher wages, Nakamura also highlights the impact of what some call “bullshit jobs”. In a book by that title, which was published last year, London School of Economics anthropology professor David Graeber argued that “managerial feudalism” in organisations has created jobs that are hard to justify even by the people doing them. This includes everything from doormen and receptionists to middle managers and public relations specialists. In effect, Graeber suggests that productivity gains fuelled by technology are fed back into a system that creates pointless jobs.
Clearly, jobs do not exist purely for productive purposes, which is just as well. As automation and robots gradually replace more and more workers, societies have to find ways for these productivity gains to be redistributed, which has not happened yet. “Policy has to catch up, quite urgently,” Nakamura says. In the meantime, the so-called bullshit jobs that are dissipating the productivity gains of automation and robots might be reasonable stop-gaps. “As long as we do not find a way to redistribute what could be the tremendous gain from automation, it is better to employ people who are doing nothing… rather than having a big social and political problem,” Nakamura says.
