Analysts warning of a spike in inflation are underestimating the psychological impact of the economic shutdown, which could push the West into a deflationary spiral similar to the one seen in Japan in the 1990s and early 2000s, according to Atlantic House Investments’ Fahad Hassan.
In a recent note to investors, Premier Miton multi-asset fund manager David Jane noted that the forces that produce inflation are plain to see – the government is paying more than 15 per cent of the workforce not to produce anything, meaning more money is chasing fewer goods, leading to higher prices. At the same time, he pointed out that powerful deflationary forces caused by job losses, enforced pay cuts and failing businesses could win out in the short term.
Yet Hassan, co-manager of the AHFM US Enhanced Equity fund, warned that anyone who thinks these deflationary forces will only be short-term in nature doesn’t understand how people tend to react to these events.
“Going into this crisis, I think one of the first things I realised is that any credit card debt is my enemy, because it is accruing at 20 per cent,” he said.
“If you envisage the fact that you can’t pay for six months, then you’ve got a problem.
“Businesses are going to have that same conversation. Treasurers of big companies up and down the country, not just those in the FTSE 100, are going to have to ask that question of ‘what do we do if this happens again?’”
Hassan said the changing mindset of businesses is already evident in the number of dividend cuts made so far in 2020. Link Group claimed the UK’s dividend pool could be halved this year and the widespread cuts seen already have forced the Investment Association to suspended yield guidelines for the IA UK Equity Income and IA Global Equity Income sectors.
Yet what interests Hassan the most from a behavioural point of view is that while most of these companies have been forced to cut dividends due to a fall in profits, many others have held back payouts even though their business has been relatively unaffected by the crisis.
“There are a lot of other companies that I wouldn’t have assumed would cut dividends, yet they have gone and done just that,” the manager continued.
“Bunzl was one that I was doing some work on because it supplies rubber gloves and masks for supermarkets. But having paid a dividend for the last 25 years, it came out and cut it. I was left perplexed, but obviously it becomes hard to forecast in an environment where you don’t know whether you will be allowed to go in a shop or whatever.”
Hassan believes that this caution is unlikely to change anytime soon and will instead become the new normal. In that way, he said large companies in the West will begin to more closely resemble those in Japan where, as of last year, the percentage of non-financial companies that were net cash was about three times higher than in other developed markets.
Fujitec is one example – in a Trustnet article published earlier this year, Joe Bauernfreund of the AVI Japan Opportunity Trust noted that almost half its balance sheet was in cash or low-yielding securities.
“Basically, they all end up becoming pseudo banks by holding these big cash balances,” Hassan added.
“People look at corporate Japan and they say, ‘these companies are so inefficient and borrowing is so low’ and all the rest of it.
“But they’ve built this mechanism to try and survive the mini crises that they tend to go through – earthquakes and so on and so forth. Because when something bad happens, they need to be able to survive.
“So corporate treasurers will be reluctant to start paying dividends until they think that those debt levels are low enough.”
And Hassan believes this more defensive stance by corporates will have its own implications which will ripple through society. With no bond yields left to speak of and dividends “easy pickings for corporate management”, he said it begs the question of how the baby boomer generation is going to fund the lifestyle it has grown accustomed to – and the only option for many retirees is to start withdrawing capital, which is fraught with difficulties.
“You’re exposed to something called sequence risk, which is where the random time you were born dictates how you survive in the years at the end of life,” the manager explained.
“If you are the unfortunate chap who was born in a year that leads you to retire when equity markets have fallen 20 or 30 per cent from their peak, then you will never make that money back.
“With the deregulation of the pension market and annuities going out of fashion, there have been a lot of people left exposed to that. That again drives this uncertainty which creates the need for greater savings.”
As a result, Hassan’s general outlook for the coming years is bleak.
“There’s a common phrase that people like to say, ‘whatever doesn’t kill you makes you stronger’. And my view is that that is a falsehood. Because basically, every time you take a hit, you’re more vulnerable than you were before,” he finished.
Data from FE Analytics shows AHFM US Enhanced Equity has made 94.62 per cent since launch in July 2015, compared with gains of 78.12 per cent from the S&P 500 and 62.97 per cent from its FO Equity sector.
Performance of fund vs sector and index since launch
Source: FE Analytics
The $61m fund has ongoing charges of 0.65 per cent.