The Continuity Of The Cycle Depends On Margins And Salary Costs


The presentation of quarterly results will be essential, in the opinion of Cristina Rodríguez, head of Global Multi Assets Solutions at Santander AM -who opens a series of interviews with the investment managers of the Spanish managers with the largest equity volume-, to monitor the companies’ sentiment regarding the recovery and the impact on their margins of the cost of energy and a possible increase in wages, apart from the lag between supply and demand in their supply chains. Not because they expect bad data, but because they will serve as a guide for the development expectations of the economic cycle, which they predict continuity in 2022.

Where do you have your focus on your portfolios heading into the final stretch of the year?

The focus must be placed on the publication of quarterly results. More than the results themselves, which are going to be good, we must pay attention to the message of the companies, especially in relation to the pressure on margins, in salary increases … Clues about how the gap between supply and demand in supply issues, which can tell us where corporate sentiment can go.

Because, if it really translates to wage pressures and company margins, it would be something that would make us re-evaluate part of our scenario. We must try to perceive in the guidance if the corporate world remains so confident of that good path and how much threat they see in salaries and margins from the increase in the cost of raw materials.

It will be more frequent to have episodes of volatility in the markets because going in one direction or another can change a lot. That is why you have to be very attentive to whether the data gives clues as to whether what you think is happening is happening within reason or is gaining weight in any of the alternative scenarios that could cause sudden movements in the markets.

Do you think there can be a ‘shock’ in raw materials or do you discard it?

The issue with raw materials is that, no matter how much prices rise and no matter how much producers want to start producing more, there is a problem of capacity and investment. As prices go up, there are businesses that begin to be profitable, but it is not something immediate.

And it would be necessary to see if this increase in demand is going to continue at these levels and that gap becomes more structural. Russia’s gestures, diverting part of its production to Europe with the idea of ​​softening prices, are positive. But in both oil and natural gas, geopolitical components come together that make it difficult to make reasonable estimates. Our scenario is that it will not happen, but it must be monitored.

Regarding inflation, with a figure of 5.4% in the United States, do you think that we are already at a turning point?

Our central scenario is that throughout 2022 we will have a much lower growth situation than this year and we will return to the deflationary trends that existed before the pandemic, a more goldilocks scenario, where economies grew but without generating major imbalances. no pressure on prices.

The worst scenario is that central banks are not able to control the rise in prices and there is low growth with high inflation, and that causes them to start raising interest rates and generates a more negative spiral. It is not our central scenario, but as soon as the market starts to price it, it generates a lot of volatility.

How high do you think the American debt can go?

We don’t think it goes much beyond 2%. The last hike has been quite fast and we would like the Fed to manage it as well as it has done so far, with a tapering starting in November and the first rate hike next year. With this scenario, we are betting on the steepening of the curve, especially with 5 and 30-year bonds, and short duration in general in all risk profiles. But this movement has been so strong that last week we were slightly reducing our short duration positions. If it goes up very quickly, the risk is that it will pull the real rate and that does affect.

In what types of fixed income assets can opportunities remain?

It’s complicated. We continue with some investments in investment grade and high yield bonds, but the potential spread reduction on these assets is already very limited.

In fact, not even high yield compensates for the average inflation of all Western economies …

Whenever we approach high yield, we do so in a very diversified way, because the issuer risk is high. In a general growth environment, it is good for these types of issuers. Although they have a very high leverage, they are usually companies that, due to their size or not very important market position, have worse ratings.

But when you invest in this type of company, you are not looking only for carry but for capital appreciation, that is, the high yield has given between 5% -7% precisely because of the reduction in the spread, and that is what it already is. Exhausted. If we have a moment of aversion to risk, that spread would increase again and even the carry would no longer compensate. So right now I don’t think this is the time to get involved, if you don’t already have it in your portfolio.

In an interview with the main financial adviser of the International Monetary Fund, Tobias Adrian, he said that half of the emerging debt is unsustainable. Do you contemplate this type of asset and in which countries?

We do have it on the radar, although at the moment we do not have great positions. The emerging economies, in general, are following a process of convergence with the developed economies. but they have levels of indebtedness far removed from them. Another thing is to bet on a country that gives a political lurch and leaves you out of the game, but as the standard of living increases, they create a middle class, they collect more … the normal thing is that the weight of emerging debt in portfolios increases. In our case, it has a weight of 3% -4% in conservative profiles.

And in China?

We mainly have Chinese government fixed income. We are not investing in credit yet. To the extent that you access the capital markets and are part of global indices, there are a series of flows that gradually feed those assets into those global portfolios naturally.

Do you think that it is going to be ‘overpriced’ in the next few years?

It depends on supply and demand, but if the interest rate of the international investor is much higher than the rate of issuance they have, this situation can be seen. In the US and Europe, what has happened with high yield has been many times the ‘hunting for yield’ of the managers, that hunt for profitability in the world of fixed income. If emerging debt begins to have that appeal, few niches are left.

The problem is, there are no more shotguns left either … many fixed income managers have lived very comfortably until now.

Yes, if there is something clear to us, it is that it is becoming more and more complicated. I make this self-criticism of whether this is what I want to happen or any other possibility is dark for next year. And it is important to monitor risks because any imbalance can lead to more volatility in the markets, fear and negative returns. Those risks exist. And when you advance in the cycle is what happens, when you come out of a recession and go towards an expansion of the cycle, it is like a party because everything is going well. But next year we will have to be more selective and we will probably have a greater disparity in results.

Variable income
In the variable income part, how do you have the distribution of assets?

We continue to favor the European market over the American one. And within it, we are having some more exposure to value. At the sector level, we have a relative value strategy open in favor of financial firms and against utilities, which we suffered a little when opening it but it is now behaving better. And where we are also positive is with Japan and emerging markets, especially Latin America.

No money enters the ‘value’. With the inverse of the PER, there are very attractive returns on the European stock market, with PER 16. But in value it is very easy today to make portfolios with PER 10, 11 or 12. What are you looking for in Santander AM?

Either we delegate to a specialized manager or we invest in an ETF with that style. It is more to look for that bias in the portfolio to invest. But Europe is value per se in its indices, which is why it has lagged behind in recent years. This year there has not been such a different behavior between Europe and the US. But if this scenario consolidates, we should see a better performance of the European market compared to the American one.

How do you position yourself in cycle and technology?

It is worth distinguishing between cyclical value and value understood as very cheap companies. We are probably more interested in the first one. Utilities is a bond proxy and in this scenario it should behave somewhat worse, although there could be surprises because there is some utility related to sustainability, which is another megatrend, which is what has led this sector to be so expensive.

And in technology, you buy Facebook you buy cheaper than the American market.

We have played some relative of the FAANG against the Nasdaq in these past months. And in the end it is a volatile topic. The significant weight of these values ​​matters, in which many times it is no longer the dynamics of the company itself but what they imply in flows of derivatives and ETFs. And there is an issue related to the power situation of some companies and how a greater regulatory framework can affect them, as has happened to banks in the past, as happened in 2008. This issue also hangs over the sector.

When do you think that the rate hike in Europe is going to take place and it is going to be an important vector?

In Europe we do see a certain normalization of interest rate levels on the curves, but this will come hand in hand with the withdrawal of stimulus from the ECB. The rate hike in Europe is not planned for us. To make a forecast beyond 2022 would be to constantly change it.

In Europe, we have not yet normalized the excesses of 2008, there was no time to withdraw the stimuli and the Covid crisis arrived. I would be surprised if it could be done so much faster now. In the US they are going to start tapering at the end of the year to start raising rates next year, and hopefully that means that inflation is under control and that economies are growing. And hopefully Europe can start moving in a direction closer to what the US has done.

Could there be an impact on bank accounts if LTROs are no longer remunerated at 1% ?

In the end, the ECB is very sensitive to the systemic risks that Europe has with banking. I do not know the impact that it may have, but they have spared no effort in making liquidity available to the system, which today is beginning to be less necessary, and that is why it is necessary to start withdrawing those stimuli, so that things return little by little. little to its course.

Is bank delinquency considered controlled?

No, it seems that indeed it no longer weighs. Manufacturing activity has begun to return to normal and now, by removing restrictions, the service sector is normalizing. The problems in supply chains are precisely because of that, because you start to have a normalized demand and an offer that tries to adjust to that demand, which had disappeared in some cases. One important thing that I would like to highlight is that, unlike other recessions, that when we have exited there has been a segment that has been very damaged, in this case it has been different.

Both companies in general and families come out with fairly healthy financial situations. Companies have seen their activity levels return to pre-Covid levels and with the ability to increase prices, and in the case of households there has been a lot of depressed consumption that has been transformed into savings. And that higher inflation is not bad when the economy is growing, it is healthy to reduce the level of debt. It is something that was lacking before the Covid: some inflation that would alleviate the debt of the States.

He mentioned Japan as one of the investment ideas. What is it that catches your attention?

It is also a very value market, it resembles the European one, and it is what we are looking for in this environment, companies and sectors that benefit from the cycle. And in relation to its fixed income it is cheap. They have also had a political change that helps to gain some momentum.

Capital flows are often undervalued, but if Japan is on the radar again, as is the case with Europe, which has once again been in the crosshairs of the North American investor and there have been net inflows on the European stock market again … So aside from intrinsic factors, it is interesting to consider these flow factors.

Are they still neglecting investing in cryptocurrencies?

Yes, but in the end the legal acceptance by El Salvador breaks one of the barriers for which the asset was not on the radar. It is an experiment and we will have to see the risks it brings. But more and more international investors are looking in this form of assets for a way to hedge against inflation and it is an asset that has much more restricted supply for the future.

All currencies have generally lost value in real terms. It is difficult to understand how someone buys something intangible that only has value to the extent that another recognizes it, and seeing countries like El Salvador that put it to the test makes one rethink that they could enter the radar.

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