“The following is a recording of a session from the 2023 PineBridge Benson Elliot annual meeting.
Marc Mogull, PineBridge Benson Elliot’s Chairman and Chief Investment Officer sat down with Hani Redha, Portfolio Manager, PineBridge Global Multi Asset, to address the dramatic shift in current market conditions, how today’s cycle compares to turning points in cycles past and what that all means for investors thinking about their portfolio construction.
I guess, it has tended to fall to me to pretend I was an economist. Well actually, yes, that's true. I actually have my degree in economics and don’t have to completely pretend. But now I've got somebody in the shop, I can go to with all of all of my questions. So let's start with this, if you don't mind, would you, in essence, introduce multi asset?
Absolutely, Marc, good to be with you all today. We're a team of 25 people managing about $15 billion in global multi assets, and we are essentially a go anywhere type of strategy. So, we cover all asset classes, in all geographies, which just means I don't get a lot of sleep. We're really assessing what type of a regime are we going to be in over the coming five years or so? What are the defining characteristics of that regime? And then what implication does that have for different asset classes? And how are they valued? What does the relative value look like across all of those?
So less focused on a short term trading strategy than a medium term out?
Well, that's right. Although you know, that's the first step of our process.That's the anchor, what does the trajectory look like? Because, as you would say, in your assessment of any asset, when you look at an asset class, you're going to value it over the full life of the investment and assess the valuation of the cash flows and the cap rates. But as you know, there'll be times when you're expecting that the market will deteriorate initially, perhaps, and then come back, or vice versa.
So what we've found is a key insight in what we do is that we look for asset classes where the fundamentals are actually on an improving trajectory in that first nine to eighteen months within the five years. So we want it to be attractively valued through the whole cycle. And then what we have found in working with the real estate team, is that, you know, what we can contribute is having this global footprint, with PineBridge, in over 15 countries, investment professionals on the ground in those locations is a very global perspective.
And in particular, I would highlight our understanding of China, being just a fundamental driver of the global economy, really difficult and opaque market to know. And our presence there and our network has helped us to use that in developing what that regime looks like because China always will play a critical part in shaping what that regime looks like. And you know, we're actually in the month, this month when China's leadership are going to be going through political change which will set up the next few years for China. So that's a live example.
Right and it's been helpful to us because the truth is we don't spend our time day to day thinking about China and you've been very generous in sharing with us how what goes on over there, can impact on us, is over here. I kind of painted a picture of a market environment that's become more volatile in the last few months. And you're not quite as old as I am, but you're no spring chicken either. And so you've seen a few cycles. And what I I'd be interested in your sharing with everyone is, is really the conversation we had most recently where we talked about this cycle, and how it's playing out juxtapose to some of the other cycles, and what that kind of implies for some of the decisions or recommendations you're making for the team and some of the things that we've spoken about.
Absolutely so this is really crucial because when we have a shock, an event like the pandemic, it tends to shift us into a new regime. And what I've learned over the years is there are a lot of people in the industry that are still going to be attached to the previous paradigm. And just assuming you know, we're going to swing back to where we were, we are going to go back to the way things were and, and that destroys a lot of value, because the valuation of different asset classes, it just fundamentally shifts, and there's no going back. And it's critical to be forward looking, because markets are going to gravitate to what that new regime looks like. And we have to figure that out, not just assume that we're going to gravitate back to some magical historical average of some kind.
So that's just an overall, why it's critical and why we look at things in this kind of regime approach. Now, if I may just rewind a little bit to understand, you know, how did we get here, it really, I think, helps to inform, you know, where we're going. So the, the last cycle, you know, which was from the Global Financial Crisis in 2008, up to the pandemic, that cycle was quite unique. And it was, you know, the shock there of the Global Financial Crisis was, as everyone knows, you know, over leveraging, and over capacity.
And so the GFC, the financial crisis was, was a balance sheet recession, where the private sector had to go through a painful process of deleveraging. Okay, there was too much debt in the system on the private side. And so there was a period of deleveraging going on. At the same time, governments, especially after all of the problems with Greece, started to really kind of get religion over their fiscal finances. So we've suddenly shifted to what I call fiscal frugality.
Austerity by another name, and that's also a drag on growth, it just means that, you know, the public sector side is also a headwind to the growth backdrop, so we ended up with a world with demand deficiency, okay, and excess capacity, excess supply because of all the build out, that led into the GFC and what what kind of filled the gap was monetary policy on steroids, so to speak, right, hyper monetary policy, just trying to stimulate and offset these drags on growth coming from deleveraging and austerity.
And so we ended up with very distorted markets and the tools they used, had very direct effects on financial assets, and they were very positive for financial assets. They didn't do much for the real economy, actually. So we ended up with a decade of very lack lustre growth, and a lot of frustration for the man on the street, the woman on the street. Financial assets had a beautiful tailwind from all this liquidity coming into the system.
Pushing real interest rates way way down, as I said, for folks who were particularly the European investor base that was looking for where do I find income? Do I find, you know, particularly income that I can go to sleep at night, trying to convince myself has got a inflation hedge associated with it? I did that slide. I don't know, a year, a year and a half, two years ago, where I talked about being trapped in the asset class.
Yeah, the search for yield, if we remember that's what we used to call it, the search for yield. So that was the result of it, it was because of this demand deficiency, excess supply, drags on growth and monetary policy going full blast to offset that and it pushed down cap rates, pushed down interest rates, desperation for yield.
Now, the pandemic comes along. And this almost entirely flips the other way. Okay. So now because we've de leveraged the private sector, consumers households are actually in relatively good shape. They don't have that massive level of leverage that they did in the GFC period. And governments are not flipping to austerity. Do you hear anybody going to austerity? I mean, even in this country, right now, they're debating how much to increase benefits and so on. Right.
Liz is going for growth.
There you go. You see, that's the opposite of austerity, and coming from a conservative government. So that side of it, the public sector is behaving very differently. Just think of the amount of support that came in the pandemic itself, huge amounts of deficit built up as a result. The household sector is in robust shape. And the public sector is not going to austerity yet, at least. And we don't think there's any appetite for that to be honest, there's just no political capital there.
And so the demand side is now not the problem. Demand is actually pretty robust. It's not going to be the source of any issues with growth. The problem now is on the supply side. So we had excess capacity, a lot of slack, unemployment was in double digits and it took us a decade to bring it down to 4%. A decade to get down to 4% last time, so there was a ton of excess supply of labour and capacity and energy was abundant.
What the pandemic has done, well first of all, we worked our way through that slack. We were already at, like 3.7% unemployment, the day the pandemic landed. So that regime was actually coming to a natural end anyway. So what the pandemic and the response to the pandemic, with a lot of stimulus did, we've brought unemployment down from double digits back down to 3.5% now in the US, within two years, not a decade. So we don't have this excess supply, plentiful labour anymore. It's the other way around. We have shortages of labour, and that's across the board. Even Europe is at record low levels of unemployment. So that's a very different picture, because it can now start to actually generate inflation, wage pressure, right, naturally.
At the same time, we've suddenly found ourselves with an energy shortage, energy supply is constrained as well, for many reasons we do not have the abundance of energy we had either, so you start to see this shaping up of stronger demand, less supply, what does that mean, for us, it means higher real yields.
And monetary policy now doesn't need to be going full blast. In fact, it now needs to withdraw because we have an inflation problem. So you're now in the process of withdrawing all of this excess liquidity in the system that was there because of all of these drivers of the previous regime. And that's a headwind for all things financial, all financial assets. There's no real exceptions to that, we are all going to have to go through an adjustment process across all asset classes, as this liquidity is withdrawn. And I think that's directly linked to what you're saying about real yields.
But I do have to ask you this, your view on this particular question, you've kind of made the editorial point that fiscal policy was pushed too hard, too long. And the question is, do you see a risk now that monetary policy gets pushed too hard too long?
So a very good question. I mean, I think we're trying to find the clearing level, how are these two going to actually work? Because if the UK, for example, right now, they're kind of fighting each, right? They're fighting each other. And that's not sustainable. I suspect the political landscape and this kind of supply demand balance means that there's no appetite to go back to very austere conditions. Governments are going to need to spend more than they used to.
And the central banks are going to need to tighten enough to keep inflation under control but may need to tolerate higher levels of inflation than they did before.
And that may be good for us. I'm going to ask you one last question and hopefully I'm allowed to ask you this one, it's a portfolio positioning question, right. In the regime that you've just described, what is the guidance you're giving to your team in multi asset about portfolio construction.
So in the near term, our base case is that we are going to have recessions. Because that's really the only way to kind of reset this huge imbalance that we have between supply and demand. We think it's fairly unavoidable, Europe is probably going to go first, in the fourth quarter, UK as well. In the US, we think we'll probably end up in in a recession, but that's going to come later into next year, it could be even as late as mid-year or second half of next year, because the US is starting from a stronger position and has less of this energy problem at the same time.
So we do expect recession in the near term. Now, that does create opportunity, right? So I was I was asked this question on TV the other day, and I said, “Look, if you keep your powder dry, and you prepare your shopping list, and you've got capital to deploy, then I'm actually quite bullish when it comes to that. Right now we are positioned in our portfolios, we’re positioned very cautiously. We were bearish all year, and we've stayed bearish all year and continue to be there. But I'm getting excited in that.
You're preparing to pivot?
Yes, I think it's going to come, I think it's within the next six months, we'll see a kind of troughing process and we would have had a pretty good reset, which will then review the best opportunity to capitalize on that. So that's one thing I would say. What you said about distress is coming and being prepared, if you translate it into a liquid portfolio that can be moved quickly. That's what we're doing as well, we're withdrawing risk, which we've done since the fourth quarter of last year. So we've stayed below neutral on our risk levels, and now preparing to hopefully take advantage of dislocations and opportunity that comes in. That's one thing I would say.
The other is that, for active management for a kind of high-quality investor, the previous regime was actually fairly difficult to try outperform it. And the reason is because this monetary policy on hyperdrive, pumping liquidity into financial markets every day, was essentially kind of a form of morpheme.
And it prevented us from really seeing reward for a discerning investor, finding good assets at the right price. Everything was being lifted and so even the cowboys were being rewarded.
That's the thing. And prudence was punished, that's another thing. If you're a high quality, risk focused manager, you effectively got punished for it, because it was you were effectively paid to be more aggressive, that is now changing, because once you start withdrawing that tide, that was lifting all boats, you withdraw that, and now assets have to stand on their two feet. And now you really need a manager who's going to be selective about what he does.
Thank you for listening and we hope you found Marc and Hani’s perspectives on the outlook for the very critical months ahead interesting and insightful. For more thought leadership please visit Pinebridge.com.