“The world has become less capital intensive,” McCaughan told FSA on a recent trip to Hong Kong. “The real big companies in the US are all tech companies based on intellectual capital – people writing code, not investing billions in buildings and equipment.
“Facebook, Amazon, Netflix Google are IP and systems. Uber and Airbnb are using models that bring idle equipment into use rather than building new capital.
“That suggests an excess of capital savings over new investment and that may continue indefinitely. If that’s the case, you’d better get used to low interest rates.”
Technology is also deflationary, he added, and the impact of new technology is not accounted for in current inflation data.
One example is that current inflation data counts online purchases as department store purchases. Yet online buying is 20-30% cheaper.
“That data provides a clear overestimation of inflation. Inflation may be really lower than indicated and that suggests low interest rates continue for a while. There is no reason why the 10-year yield, about 2.35% currently, should be any different in one year’s time even though the consensus is for rising interest rates.”
No bubbles
Breaking from consensus, McCaughan believes the opportunities are in US equities. Six months ago PGI managers moved away from buying dips in international markets and sold into strength, he said. But in the US, it’s still buy the dips.
“We continue to hold full representation in US equities and continue to buy the dips and avoid excessive valuations in other places.”
He doesn’t see a market correction in the near term. “The US market doesn’t have bubbles yet,” he said. He referred to the internet boom in the late 1990s, when the average price-to-earnings of the S&P crossed through 20x in 1998.
“When the market was ready to collapse [in 2000], the average price-to-earnings was above 25x. That to me is a bubble. We haven’t got there yet. We’re probably in 1998.
“The average price-to-earnings on the S&P, post-tax reform, will come down to the low 20s again. If it’s lower for longer interest rates, a 20x P/E is sustainable — it’s neither expensive nor cheap.”
He said policy errors in 2019 could trigger a recession but added that a recession is too difficult to predict. He believes a trigger could come from outside the US, such as war in Korea, disruption of oil supplies from the Gulf or the collapse of a European bank.
“I don’t think these [scenarios] will happen. Next year doesn’t feel like a sea change from this year. With the negative tail risk all you can do is diversify and watch. Don’t sell on the basis of 20% risk.”
