Henderson: Inflation Forecasts are Too High

Hello, and welcome to the Morningstar series,
“Why Should I Invest With You?” I’m Emma Wall and I’m joined today by John Pattullo, Manager
of the Henderson Strategic Bond Fund. Hello, John.
Good morning. So, at the tail end of last year you were
one of the few people putting their head above the parapet and saying that inflation was
not going to be a big problem as many were predicting. In fact, we were entering into
deflationary environment. And you didn’t get that too far wrong, did you?
No. I mean, Jenna and I have been of the view for years that the world, Europe essentially,
is turning Japanese as in low growth, low inflation, suppressed volatility and suppressed
defaults. And that’s exactly what has happened. The Trump thing confused investors I think.
We were fairly dismissive of it. We did a lot of reading and were frankly uphold actually
by all the investment banks we read. Whatever model you put Trump in, good Trump,
bad Trump, maverick Trump, whatever, most of them were invoking a material change in
growth or inflation, slightly to our surprise. Having said that, we were respectful of the
Trump trade because we didn’t know. I mean, you can’t ultimately know. So, we did shorten
duration a little bit with a view to getting longer again because we didn’t think that
was a regime change. The other thing about the Trump trade was
it was basically, because China has reflated the world in early 2016, he got elected when
the world was ticking up in a synchronized global economic activity and he took all the
credit for it even though he hasn’t really done anything. So, all the equity managers
were relict on this and obviously, there was big rotation in equity markets for a while
until year end of 2016. But 2017, it’s actually the value – the growth stocks untag have
been performing and bonds have been performing again. So, we do feel pleased we called that
correctly for our clients. And the other thing that slightly confused
matters were commodity prices, weren’t they? The fact that oil doubled and many people
said, well, this is it, this is inflation. New norms of 3%, 4%, double what the bank
is recommending. And actually, that hasn’t come through?
Yes. And I think virtually all the street analysts had 10-year treasuries up at 3% or
higher. And some of the leading banks still have four or five U.S. interest rate rises
penciled in and we think you’ll get – well, you get one this week, you might get one more
and we think that’s probably it. I think the equity community, if I could be so bold, some
of them get a bit confused with headline inflation compared to core.
So, the oil price doubles if headline inflation goes up; mathematically, of course, it does.
The bond community is a little bit naughty because when the oil price halves, they will
get a bit deflationist. Whereas if you look at underlying core CPI, it hasn’t really done
anything. So, always look at core. Don’t get distracted by what’s going on in energy and
oil. But you can kind of felt that the equity market, well, there’s a reflation trade coming.
I’ve been waiting forever. And here it is, it’s fantastic. But it didn’t actually last
very long at all and we think it’s faded pretty fast.
So, the first half of this year has certainly been that picture. The question now, however,
is what the next half of this year and indeed, going into 2018, because, well, with any call
you can only be right until you’re wrong? Yes. And markets are pretty much shockproof
events. So, even this time last year, this secular stagnation that Larry Summers’ thesis
got almost too mainstream. Everyone’s bought – bond yields were really low, U.S. treasuries
were down at 1.3% and then they doubled from 1.3% up to 2.6%. Today, they are at 2.2%.
So, is it in the price? Well, I think, quite a lot of it is in the price. Having said that,
everyone says, well, the uncertainty of bond market got to end tomorrow; unless we’ll sell
bonds, it’s all disaster. Which they’ve been saying for about…
…forever. And all our clients are shorter bond, they are all shorter duration, all of
them, almost to a tee, because we travel up and down in the country. We’ve been in America
travelling as well. And Jenna has got the same feedback from our American clients as
well slightly to our amusement. And a lot have gone into alternative products, peer-to-peer,
infrastructure, lots of so fashionable stuff which we purposely avoided, all that stuff
and it’s a short-duration asset class. So, you haven’t got the benefit of duration when
risk is off. So, I think, quite a lot of it is in the price.
Well, I’m just not convinced it’s just because the 5-year down trend is long ended too, but
it doesn’t mean you suddenly get a massive uptrend on other side, maybe a basis for the
next three or five years. And (indiscernible), you get a little bit of a cyclical uptick
and bonds sell off there, and then you get the long-term structural demographics, digitization,
too much debt. All this stuff we’ve spoken about for years will reassert itself.
As of today, I think, treasuries are kind of fair to cheap, but they have moved a bit
and the positioning has moved. So, everyone was massively short when the economic data
was just turning over and obviously there was a short squeeze, bond yield rallied, prices
up. And as of today, I think, there’s a bit more in it actually. But you can’t be more
bullish when yield are at 220 than you were at 260.
John, thank you very much. Thank you.
This is Emma Wall for Morningstar. Thank you for watching.

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