Reflecting on his more than six decades as an asset manager, Dan Fuss says that climate change is now the greatest challenge facing society and the markets.
Fuss is vice chairman of Boston-based Loomis Sayles and manages the firm's flagship Loomis Sayles Bond Fund (LSBDX). He spoke on October 18 at the CFA Society’s annual fixed income conference, which was held in Boston.
Responsible policymakers, particularly central banks, are trapped by a “two-step environment,” Fuss said – climate change, which is happening fast, and the need for a global policy to address it.
Bill Gates says it is too late to control some aspects of global warming, like rising sea levels and air quality. But Fuss said the important first step is for the dominant political powers to unite. But, he asked rhetorically, how do you deal with the problem without getting China’s buy in?
Citing Thucydides, he said the lessons of history are that conflict of this scale normally ends in a shooting war. “We need to work together on a productive basis in a friendly rivalry,” Fuss said.
The U.S.-China relationship is the dominant theme for markets, according to Fuss, but other geopolitical tensions are at play. Net asset flows are from Asia to the safety of the U.S. and Europe. Japanese life companies are selling assets to invest in dollars. Political disorganization and regional clashes are driving those flows, Fuss said.
Migration from the Middle East has driven a lot of political tension and creates investment risk, Fuss said. “It alters where we put our money in the Loomis Sayles bond fund, to avoid unstable regions.”
Fuss acknowledged that political uncertainty plays a larger role in portfolio risk assessment. It is harder to tell whether measures will pass Congress, he said. Polarization, on a global basis, makes it much harder for compromise and to create positive economic frameworks. “This greater uncertainty increases investment risk,” Fuss said.
Not much has changed since the last time he spoke at the conference, two years ago, Fuss said, “except that it has gotten worse.”
Reflecting on changes in the bond market over the last 11 or 12 years, he said inventories are smaller and bid-ask spreads are greater. There are only six major market makers now, Fuss said, but he did not identify those firms. Some credits, like Verizon, have a good market. “But there are fewer names like that,” Fuss said.
The total debt outstanding is less and dealers are acting as agent, Fuss said. “That is a very important, fundamental change, and is due to changes in regulation and to low rates,” Fuss said, “which make holding inventory too costly.” The market is less liquid and that is a structural development that won’t change until rates are higher and dealers can hold inventory profitably.
On the economic side, Fuss said that some regions of the U.S. have weakened, particularly in manufacturing areas. He questioned whether the business cycle must die of “old age,” and mentioned that has not been the case in Australia, which has enjoyed 27 years of economic expansion. The biggest issue is trade fear, Fuss said. “Anyone would be foolish not to take into account that the flow of trade could be halted or slowed,” he said.
Returning to the climate change theme, Fuss said the global supply chain has become vulnerable to the weather. Companies have addressed that by moving production geographically closer. But production in places like Mexico are under threat of trade disruption, he said. “It is a legitimate risk that could get out of hand.”
Turning to monetary policy, Fuss commented on the evolution from a mostly domestic-oriented view to a global perspective.
In the spring of 2017, Fuss said the Fed noted in its minutes that it considered the “global consequences” of its policies. Central banks are well aware of global conditions and have a global focus, he said, beyond their typical dual mandate of price stability and low unemployment. The U.S. economy is “pretty strong,” he said, but he questioned whether we should raise rates. “It won’t impact capital flows.”
The Fed is “trapped,” he said, by the worldwide situation. Similarly, the EU is trapped by its internal conditions.
Spreads have compressed and values are “scarcer,” he said, typical of a late-cycle environment. “We won’t make a lot of money in this environment,” he said, “but don’t say that to the clients.”
Environmental, social and governance (ESG) issues are playing a bigger role in his investment decisions. Fuss also said there is not enough wind or solar energy potential. The answer, according to Bill Gates, is to pursue ESG locally but focus on new technology to stop climate change. “We need massive investment to address this,” he said, “from startups to venture investments by major companies.”
He wants to invest in companies that are trying to solve climate-change-related problems, either in the U.S. or outside. For example, China is generating solar power in the Gobi desert. “Costs have to be driven down,” Fuss said, “as they were with semiconductors.”
Fuss said that most of the big changes he sees now he has seen before, including population migration. “When you look at the situation with climate and the emergence of China,” he said, “it is very easy to get down and depressed. But, psychologically, it is like raising teenagers. They grow up to be wonderful people.”
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