You're listening to Strictly Business Podcast with Lindsay Williams.
With me is Peter Kent, Co-Head of Emerging Market Fixed Income at 91 in Cape Town.
We're going to talk about the following.
The headline is, Reframing Fixed Income, the old rules are no longer fixed.
Peter, welcome.
And are you telling me with a straight face that the old rules that you've
learned over the decades, I think,
for fixed income are now obsolete?
there's a blurring of lines.
Fixed income is no longer fixed income.
Is that what you're saying?
Hi, Lindsay.
Thanks for having me.
I am saying that, but can I maybe add a little, a layer of detail of it?
Yes, please.
So I think there's a couple of observations.
The first one, which we've been talking about for a few years now,
is this concept of the EMification of DM.
So the blurring of lines between the way that emerging markets have been behaving
and
trading and how developed markets have been behaving and trading.
That is one sort of blurring of lines that we've been talking about for a while.
And then the sort of more recent one is the nature of how
developed markets fixed income has been trading.
in relation to equities, in relation to cyclical risk.
It just hasn't been behaving defensively.
And we can get into some detail on both of those.
Just before we get into that detail,
are you saying that developed market bond markets are no longer a safe haven?
And that's been evident.
I mean, we've needed safe havens over the last few months.
You're saying that they're not a safe haven.
And in the old days, as a layman, I used to think, well, if equities are going up,
then bonds are going down.
No.
the case, Peter.
Yeah, so that is the exact point.
So the point is this, you know, in my 25 odd year career of being in the bond
market,
when you look at the nature of economic shocks that we have to deal with, they've
been demand shocks.
So this is a little bit economically quirky.
But think about recessions, for example, think about the GFC or previous
recessions.
What tends to happen is business investment tends to go into contraction,
people consume less.
So you have what we call a demand shock on the economy.
That demand shock is relatively easier to model as an economist,
and it's relatively easier to deal with as a policy maker,
because what happens is as that sort of cyclical growth starts to deteriorate,
because demand is coming down, inflation comes down at the same time.
So as a policy maker, you just need to stimulate fiscally or from a monetary
perspective.
And the markets can deal with that in a way where cyclical assets like equities
have a tough time.
But because inflation is coming down, bonds have a good time.
So they help diversify.
Now, what we've had over the last five or 10 years is more supply shocks.
So think about Brexit.
You know, that started in 2016.
Think about the Russia-Ukraine war where we essentially had a whole bunch of global
commodities and agri-products.
ripped out of the global economy.
You had trade also impacted.
We've had COVID.
I mean, that was the ultimate supply shock where the world had to shut down.
So all of the usual logistical and trade lines were closed.
And then more recently, we've had tariffs, which is a big supply shock.
So what happens in a supply shock is growth goes down.
But because there isn't as much supply as there was in the past, inflation remains
sticky.
So as your stocks and your more cyclical part of your portfolio struggles,
the fixed income part of your portfolio doesn't help you nearly as much because
inflation doesn't come down.
So that is one of the key differentiators in the last five years, I would say, to
the previous 20 of my career.
We'll talk about the consequences, rather the future, at the end of this chat.
But all the shocks you've talked about have been exacerbated in the first few
months of this year, notably with tariffs, which you've mentioned.
but also The way that the world conducts itself, the world order, you say, has been
turned on its head.
What do you mean by that?
I mean, I know what I think when I think of the world order being turned on its
head.
The relationship between China, the United States, Europe, everywhere seems to be
completely different.
And that obviously affects markets.
Yeah, I think I have to tread carefully here and stay away from political
statements.
But it's plain for everyone to see.
You know, we had a post-Bretton Woods.
economic and financial architecture that essentially meant that America would guard
all of
the sea lanes, would guard all of the trade.
America would consume global products, would run a trade deficit,
would essentially export the industrial sector to the rest of the world.
And in return, the rest of the world would then invest in U.S.
assets.
U.S.
bonds would help them sort of fund this endeavor.
That has been a financial architecture and a financial system that existed for most
investors' memories.
That is getting torn up at the moment.
You know, the Trump administration is, from an imbalance perspective, you know,
they think the kind of trade deficits that they're running are ultimately
unsustainable for global trade.
So they are trying to create a more sustainable world.
sustainable global trade environment.
And from a national security perspective, you know,
they feel vulnerable that they have to rely on the rest of the world for quite a
lot of their manufacturing.
I think COVID was a shock to the system where there was a medical emergency and
they couldn't provide what they needed.
So the U.S.
is trying to rebalance trade, is trying to get the industrial sector spurred on shore
again in the U.S.
so that they can in their opinion,
improve the sustainability of global trade and from a national security perspective,
look after themselves and make sure that they can manufacture whatever they need as
a country.
That is essentially the global trade and financial system turning on its head.
Yes, and of course, that means that traditional defensive property has come
into question.
So somebody constructing a portfolio, for example, and saying, well, I want this
risk via equities and whatever it is.
But of course, I need a defensive quality, whatever percentage they assign.
That percentage may have to be called into question going forward.
Lindsay, I mean, it's a really interesting point because, you know,
we started this by saying that developed market bonds haven't been as defensive as
the past.
Something that's new over the last couple of months is we've spoken about the U.S.
administration and changing policy.
The result of that is there's policy uncertainty and there's credibility
questions,
and the dollar has been weakening in environments where it should be
strengthening.
You know, normally when there are incidences of economic shocks, normally
when there's geopolitical shocks,
everyone goes running into the arms of the dollar.
That has not been the case for the last two to three months.
So it's not just developed market bonds that aren't behaving defensively.
a lot of asset classes that we normally use as defensive assets places to hide.
There's question marks over.
So what are the implications of that?
That doesn't mean that you should sell your developed market bonds en masse or
get rid of all of your dollars.
It just means that the nature of risks have changed.
So owning a 30-year bond in an environment of supply shock, you know,
has interest rate risk that you probably underestimated.
So you probably need to be diversified more than you've been in the past, and you
probably need to own.
more of a basket of shorter dated bonds and longer dated bonds.
And equally, you used to have a significant portion of your portfolio in
dollars as a defensive allocation.
You need to think about Swissy.
You need to think about yen.
You need to think about euro.
You need to think about some emerging market currencies, Asian emerging market
currencies.
Taiwanese dollar has been unbelievably strong over the last couple of months.
So all of this points to an environment where you need to diversify on dimensions
that you hadn't really thought of
before.
That dollar factor is so, so important.
It wasn't that long ago, Peter, that I was talking to currency analysts and we were
talking about the dollar almost reaching par with the euro.
Now I'm looking at a euro dollar of, I don't know, 115, something like that.
And if you see the way that markets are reacting to the weaker dollar, i.e.
gold, that's a great example.
It's just one of the factors that's driving gold.
But also, the weak dollar is sort of taking away the super risk reputation.
of emerging market debt.
Is that the case?
I'm not going to join the dollar pylon.
There seems to be, you know, there seems to be a lot of market commentators,
investors with a smile in their face cheering on the demise of the dollar.
I'm not one of those people.
I think when you look at what the dollar has done over the last decade post the
global financial crisis,
it's pretty much moved one way in a rally.
Now, why is that?
You know, in an environment where balance sheets were being constrained after the
global financial crisis,
nominal growth was in short supply across the globe.
You know, there was essentially fiscal policy, balance sheet policy was
throttling the global economy.
And the only place that could grow healthily was the U.S.
You know, through big tech, they could innovate, they could create nominal
growth.
So the U.S.
cannibalized capital for the last decade for good reason.
People were putting it there because it had good return prospects.
That is going to change going forward.
The prospect of supply chains being rewired, the global order being put on its
head, means there's going to be a lot more investment,
there's going to be a lot more construction.
Unfortunately, there's going to be more investment in defense, which is ultimately
an industrial product.
So nominal growth is going to be higher than the past.
Equally, inflation is going to be stickier for the points that we've discussed.
So...
nominal growth will not only be a U.S.
phenomenon for the next decade.
It's going to be shared more widely.
So capital will immediately be shared more widely.
That is an environment where the dollar doesn't do what it's done over the last
decade.
That is very important for emerging markets because emerging markets are
ultimately measured in dollars.
So the denominator is in dollars.
You measure a dollar return.
So when the dollar is rallying, that's a high hurdle.
And then obviously the dollar.
is a source of liquidity for a lot of emerging markets.
A lot of emerging markets borrow in dollars, they trade in dollars.
So if the dollar is strong and in short supply, that acts as a handbrake to
emerging markets.
So the dollar shadow, I call it, which is a grinding,
rallying dollar for the last decade, this has been a shadow for emerging markets.
That shadow is probably gone.
I don't think, I'm not sitting here saying that the dollar is going to go to hell in
a handbasket.
But, That shadow that emerging markets has had to deal with for the last decade is
surely going to change for the next decade.
That's quite important.
Peter, you're co-head of Emerging Market Fixed Income at 91 in Cape Town.
So you've got to get on your soapbox now and talk about emerging market debt as a
diversifier.
You make the point in your piece that there's never been a better case for
diversification.
So please put that case.
Lindsay, I would like to think I never get on a soapbox.
box.
Half of my career has been spent in developed markets and half of it has been
in emerging markets.
I like to consider myself as a balanced representative of all bonds, to be honest.
So from a balanced perspective, I think this point of diversification is very,
very important.
Not because you need to pick the winners, but a global order that's turned on its
head,
an environment where inflation is going to be sticky because the nature of shocks.
have changed to supply shocks means it's an environment where you actually need to
try and avoid the losers.
So you should be diversifying far and wide to preserve capital.
The other point as well is when you look at markets across the globe, values are
generally stretched.
And that's probably the same for most cyclical assets.
So the next decade, the next five to 10 years, you're not going to get massive
capital uplift either.
Not like we've had over the last decade.
You're probably going to have to get much more of your returns from income.
So an environment where you need to diversify more, where traditional asset
classes are not trading as you expect,
EM really does appear as a place where you should consider.
It should be at the global investor table.
And I think what frustrates me as a balanced person looking at EM and DM is EM
gets a bad rap,
whereas EM policy has actually been quite orthodox over the last five or 10 years.
You know, we had a...
EM had a tough time around the taper tantrum.
And on average, we got our act together since then.
So EM really should be at the global investor table, not as a majority holding
in a portfolio,
but certainly something in a new world when the rules have been redefined, it
needs to be there as a diversifier.
It's very interesting indeed.
And I'm going to give you the last question now.
And it's quite a difficult one, even for you.
Is this just a once-off?
I mean, you said you've been 25 years in the market and you've learned the way to
do things and the way things behave.
Are you saying that potentially the old ways are now gone and this is not a
once-off and this is how
things are going to be in the foreseeable future?
I think when you look at the underlying reasons behind what I'm saying, I don't
think it's a once-off.
It feels like a multi-year.
decade thing you know so so supply chains being rewired um
supply shocks and growth and inflation moving hand in hand this is a phenomenon
that's happened multiple times likely to
be uh repeated it's just an environment where the underlying factors suggest that
this
is going to be a multi-year
type thing nominal growth inflation being sticky um you know i think
When you looked at the global financial crisis and you saw the way that regulators
and everyone dealt with that,
everyone essentially contracted balance sheets.
That was a force that then played out for the next decade.
More investment, the world changing, supply chains changing, the nature of
shock changing.
That is not a temporary phenomenon.
That's something we're all going to have to deal with over the next five to 10
years.
Peter, a fascinating subject to brilliantly describe by yourself.
Thank you very much indeed.
Peter Kent is co-head of Emerging Market Fixed Income at 91 in Cape Town.
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