It’s not every day you hear someone talk about the benefits of investing in U.S. bonds and the U.S. dollar – arguably the two most feared investments among people who expect an economic recovery. But Don Rich, head of tactical asset allocation at MFC Global Investment Management, isn’t particularly upbeat about that recovery and has taken a somewhat contrarian approach. He’s even bearish on commodities.
He visited The Globe and Mail on Monday afternoon, and here’s a (slightly) edited transcript of our conversation.
On why he likes bonds at a time when some observers are worried that a bond bubble has formed.
Rich: I think the prospects of a bubble are very real. But we still think the 10-year U.S. Treasury bond can move from 2.5 per cent to as low as 2 per cent. There isn’t a whole lot of room let to run, but there is a lot of convexity at these low rates so you can get some return.
The big thing is finding a place to hide. We think the global economy started its down cycle last October-November, and it was led by the Asian countries. The U.S. and Canada and Japan were the last three into the down cycle. So during May, there was a place to hide: U.S. and Canada and Japan.
Right now, all the countries we track are in a down cycle, so there’s no place to hide. That means that you’re going to move into bonds, even though there’s not a whole lot of room left for gains – and you’re going to be long dollars.
On why he’s thinks the U.S. dollar will rise.
Rich: The market so far has had a textbook reaction, with the prospects for QE2 [quantitative easing] being essentially an interest-rate cut. The dollar weakened in response to that, and the backdrop was the competitive devaluation going on.
The second effect is not going to be textbook though. It’s going to be a flight to quality. QE2 is a response to slowing macro-economic conditions, and we’re going to see that with the labour numbers and the manufacturing numbers. There’s going to be a flight to quality and a demand for dollars.
When will this transpire?
Rich: It’s very hard to project. We’ve set up the portfolio in anticipation of these events, and just let things transpire as they will. We do think we’re in a euphoric state of QE2 right now. It’s going to be very hard for Federal Reserve chairman Ben Bernanke not to disappoint next week, given the high expectations that the market has. It could be very soon or over the course of a few months. It’s hard to tell.
Will another round of quantitative easing work?
Rich: No. QE2 is a liquidity add. QE1 had some degree of success because we had a liquidity crisis. You’d be hard-pressed now to find a liquidity crisis that needs to be solved. So the primary effect of QE2 is going to be disappointment.
And the secondary effect is that it lowers borrowing costs and therefore encourages consumers to borrow more or banks lend more. But we’ve already seen rates move 150 basis points, and yet mortgage applications in the United States are near all-time lows.
So we went from 4 per cent down to 2.5 per cent, but that didn’t stimulate the U.S. consumer to borrow. So if we go from 2.5 per cent down to 2 per cent, what makes you think it’s going to work this time?
On why he’s bearish on commodities.
Rich: Commodities trade very tightly with global industrial production. Commodities are the input for the manufacturing process, and global IP is decelerating. In some countries, it close to contracting.
In the United States, a lot of people talk about double-dip or no double-dip, but I think you have to put a finer point on that. A double-dip in the manufacturing sector is a very likely scenario. We’ve already seen some regional surveys that are below 50, and if you look at new orders and other leading indicators, they are already below 50.
Even though copper is hitting highs and oil is breaking $83 a barrel, again the fundamental backdrop just doesn’t support that. It’s not 2008; it’s not the end of the world. It’s just slow, more stagnant growth while the global imbalances correct.
But what about the role of China, a big consumer of commodities?
Rich: The big thing with China is self-sustainability. It is true that they are consumer more than they did five years ago. But as a per cent of gross domestic product, it is actually going down. Consumption was 39 per cent of GDP five years ago. Today, it’s 35 per cent – compared to 65 or 70 per cent in the United States.
The question is, is there fundamental growth going forward. We look to imports to see if there is anything in the pipeline, and we’re not seeing it.
