ALAN HIGGINS: You're buying IBM bonds, 10-Year IBM bonds, 11, 12. I think that was 1990s, right, early 1990s. Seems like something out of planet Mars. We're not going back there.
How many people do you see are bearish on equities?
I was a bond man, always a bond man at my heart sitting here, equities is the place to be.
The rating agencies are really, really underrating the national champion banks because of memories of '08-'09.
LARRY MCDONALD: I'm Larry McDonald with The Bear Traps Report. We're really looking forward today to bring you Alan Higgins, Chief Investment Officer of Coutts Bank, the oldest bank in the United Kingdom. We're going to take a look down the road ahead, at not only Brexit, but also the debt-laden countries all across Europe.
ALAN HIGGINS: Larry, great to see you.
LARRY MCDONALD: Thank you for joining us on Real Vision, The Larry McDonald Series. I'm really fascinated for this, to sit down with you, because there's very few people that have started on the wealth management side and on the institutional buy side, which is the asset management side. Very few people have been able to make that cross. How'd you get started? And what was your real passion, say 20 years ago?
ALAN HIGGINS: Sadly, it was longer than 20 years ago, it's actually 30 years ago, just pre the '87 crash. So, how I get started, like a lot of younger people, especially then, was not a particularly organized way. My passion was math. So, I was good at math. So, in the mid-1980s, I was already- you're in bonds. So, your kind of area because bonds are mathematical. Even though I fancy doing equities, I could see the growth there. I can see the story, if you like, embedded in equities, but they put me in the bond department, which is great, because actually, as you know, it makes you a macro thinker. So, if you want to become more senior, it's great to have that macro start.
So, I started there. And I guess for all of us, why do we do investing, but the passion is that it's a puzzle, right? It's a really hard puzzle. You have some information. Certainly, you don't have the full information, you have many participants in the market, which you have to make some judgment to. And then you have to place some might call it bets, but place some positions, and weighted probability type of investing and it's solving that puzzle would be my passion.
LARRY MCDONALD: Legend has it that you run the Queen's money?
ALAN HIGGINS: Well, look, I will if I could. So, you would be pleased to know all client information is confidential. But on that matter, what we can say that it's a matter of public record. And if you understand that, then you can go back to the Greenspan days when he used to speak, [inaudible].
LARRY MCDONALD: Yes. And when you think of asset management today versus what you were doing on the buy side, what do you think is the major difference and different trends that you're seeing, difference between the buy side where you're managing money professionally versus now?
ALAN HIGGINS: I'd like to think I'm still managing money professionally, it's just what you add, right, different wealth. So, institutional asset management, essentially, there's less constraint as a less constrained environment, but still managing money. But in particular, with regards to taxation. You're typically managing sovereign wealth fund money, no taxation, pension funds, or it's all wrapped within a fund and the taxation element is for the end customer at the end of the day, if you like, whereas in wealth, it's still the same job.
So, still, as we speak today, how close is the US to recession? How long is this cycle? What's the outlook for the dollar, gold, equities, bonds, et cetera? It's the same job, but you have to take into account private clients, group them efficiently, because they're interested in the after fee after tax return. And that's different because clients will have investments in their own name. So, that's the only nuance, but effectively, it's the same job.
LARRY MCDONALD: That's very rare. I've been all around the world with our Bear Traps clients. We've got clients on the buy side, wealth management- and to see a staff the way you run your business and you have to manage so many people, it's a real team. You're the Chief Investment Officer of Coutts Bank, but you run an asset management team now.
ALAN HIGGINS: So, we have an asset management team. You're right, we do have a lot of people and I suppose if you look at institutional- some institutions are large, of course they are. They are the BlackRocks, Fidelitys of the world. But it's certainly possible to have a very small boutique in institutional asset management as we know. They are rare, but they do exist in wealth. You need scale, both from the investment side because of the complexity, but also on the coverage side, covering clients. So, we have many, many bankers or relationship managers that cover clients directly.
LARRY MCDONALD: Tell me about the family offices here in the UK versus the United States. Do you see any different trends and asset management with-? Talk to us, a lot of our viewers are in the family office now.
ALAN HIGGINS: Yeah. So, family offices, there are similarities. I would say what- I'd be interested in what you see in the States, but I would say that, frankly, a move away from the liquid capital markets and a move more into private equity.
LARRY MCDONALD: So, moving away from like, IPOs and bond deals?
ALAN HIGGINS: Yeah. So, still some involvement but move, move away from the volatility of the capital markets. I think I still see the industry is scarred from '08- '09. And then particularly here in Europe, we had '11-'12. And of course, we had it in the US, it was just a correction, really. But in Europe, it was actually a bear market with the recession. So, we had one after the other. So, very scarred.
So, what I see with the family offices is that yes, they will come to us and use us for some of the liquid asset management still. But an increasing desire to either to be part of private equity deals with the funds. But actually, something that we do offer is direct private equity. So, this is not an advert for Coutts, but just as a difference. And it is partly for the private offices, we offer liquid portfolio management and direct private equity, stakes in businesses. What we don't offer is the classic- to pick on a few names KKR Blackstone Funds, we offer the direct private of equity as part of a service for those, especially for those family offices.
And there's real interest in that. And, of course, what we've seen in the States, we see echoes of it here and that a lot of companies are staying private for longer.
LARRY MCDONALD: When you think of how cheap UK equities, United Kingdom equities relative to the rest of the developed markets, relative to the United States, you're talking about- on a PE basis, you're talking about 300 basis points cheaper?
ALAN HIGGINS: True. So, the UK equity market is cheap, and the currency is cheap, that currency is undervalued on longer-term measures and interest rates are going up in the UK eventually we believe. So, yeah, there is a double whammy of UK equities. But I think it's fair to say if you compare it with the United States, for example, although the UK is a very international market, it's quite old economy international. It is major oil companies. It is some very good drinks companies. So, Footsie 100 for example, so 80% of revenues are outside, outside the UK, very international.
LARRY MCDONALD: So, the Footsie, 80% of the revenues are outside the UK?
ALAN HIGGINS: Those are very international companies, but what we don't have here in the UK or more in Europe is the Microsofts, the Apples, the Amazons, we don't have those companies. So, if you set to adjust those numbers, not trying to get geeky, take into account the weight of tech in the US and sector just the UK is less cheap. But we really agree with you, it's still cheap. 5% for yield, a cheap currency and actually, for investors in the US, if they don't want to take the currency risk, just want to take the equities, they get paid for currency hedging that equity exposure back into the US. So, you get paid about just under 2%, to 1.5% and 2%. They're hedging those UK equities back into the US.
LARRY MCDONALD: I'm thinking I'm looking at the Brexit. And we're almost three years into in this June, next month. We're talking about something that's been dramatically priced in. I'm talking about European equities, UK equities, we're talking about tariff threats from the White House that have been out there for UK, more so German automakers for like the last 12 months. So, you're talking about German equities, especially UK equities, that have been wrist with risk production. When you get that clarity that markets love out of the Brexit probably by the end of the year. In other words, when we finally get that, if they've kicked the can to October, don't you see a fairly impressive rally in the pound in the UK sometime probably commencing in the fourth quarter?
ALAN HIGGINS: Yeah, Larry, I think you're right. So, the probability of no deal, which for most people is the nightmare scenario, not for everyone. We're a broad church here in the UK, we have different views, even inside Coutts. So, some people think no deal is perfectly fine. But most analysts think no deal is going to be very, very bad. The probability is low, but it's not zero. And it could rise with a different Prime Minister.
So, we have to still focus on no deal going back to what I said earlier about probability waiting are thinking, but you're right. The most likely situation is either some deal or even a second referendum. In a way, all of these seem impossible. Some deals seems impossible. No deals seems impossible. Second referendum seems impossible. But we know one of them is going to happen after July. So, they have to add up 200%.
But I think you're right, there's so much pessimism in the UK, in the pound and also the eurozone stocks. You will have a pop and a rally. We do think that markets are not very trusting at the moment. They'll want to see evidence in the UK growth figures and to some extent, the eurozone growth figures. So, the initial pop, but the long-lasting gains in Sterling and equity, European equities, including UK will come when the when the data comes through.
LARRY MCDONALD: With your background as the Chief Investment Officer of this 300-year-old institution, your background in fixed income and the bond side's very impressive. And I look around the world, the consensus is around the world now, we've got 10 trillion, 10 trillion of negative yielding bonds on the planet Earth. But on the other side of the coin, on the planet Earth in the last five years, six, seven, I guess 10 years, we've had some defaults here. We've had a default in Greece, essentially, Puerto Rico, Venezuela, Argentina's on the brink.
At some point, because central banks have kept rates so low so long, because the moral hazard in fixed income has been out there for so long, the credit quality on the sovereign side. So, the government bond side around the world has deteriorated massively. We have very few AAA credits on the corporate and sovereign side. How do you manage risk around there? And do you think that in the next say, two, three years, we're heading to a regime of higher yields because of higher credit risk?
ALAN HIGGINS: It's a good point. And you're right to point out we've had a lot of credit risk. Let's break it down, though, into the two components. Because one thing I would first focus on is the 10-Year Treasury, everything's priced off the 10-Year Treasury. And you and I have traded bonds for a long time. And you'll know that's incredibly difficult to get right. It's almost like a commodity, and it's very pure and very accurate. And what is it telling us? We think it's telling us that forget any significant high real yields like we used to see. So, at the short end, we used to see real yields of 3%. Let's just think about that in abstract.
So, what did that used to mean? That used to mean, for example, you could place your money on deposit with JP Morgan on a 3% real for taking no risk effectively, or even owning a T-bill and getting 3% real. Maybe that was the anomaly. And that's what the market is telling us, we're on a lower rate because of whether it's the secular stagnation argument. So, we think the Treasury market is right, the 10-Year Treasury knows that the rate structure won't go very high. That may be wrong. But let's just say that there may be some truth in that.
But if the 10-Year Treasury's stuck there, then basically, what you're saying is that the credit spread on top could be wider. And after the huge rally this year, I have some sympathy for that. It could be and yes, and you have to be very selective in emerging markets in particular, as you highlight, but you and I've been around when the 10-Year Treasury was '10, forget five, six before '08, '09, '10- plus a credit spread. So, you're buying IBM bonds, 10- Year IBM bonds, 11, 12. I think that was 1990s, right, early 1990s. Seems like something out of planet Mars. We're not going back there. It is a completely different world.
And actually, if you go back to- again, to be a bit geeky student of economic history, '50s '60s, zero percent real yield was the norm. It's only when you and I were in our careers where we sell 3% real is what I want. So, maybe that is the game changer. So, not as pessimistic as you and I'd make a wider point. I'm sure you see lots of almost no analyses that mean reversion to five, six, I think you're looking for three, four. Now, ultimately-
LARRY MCDONALD: I'm thinking three to 4% of yields over the next 18 months.
ALAN HIGGINS: Yeah, that, you'd have to be pretty buoyed in economic conditions to get that you can see it and maybe we will, but no one sees five, six, and no one sees 10, right? So, there's no big mean reversion in rates. Okay. So, the point I make is that how many people do you see are bearish on equities and the equities need to mean revert? Whether it be the CAPE, sickly adjusted price earnings ratio, or just multiples at 17, 18 times?
LARRY MCDONALD: Yeah. So, a lot of people think equities need to mean revert. That's where they thought.
ALAN HIGGINS: Well, no one thinks bonds need to mean revert.
LARRY MCDONALD: Nobody thinks?
ALAN HIGGINS: Nobody.
LARRY MCDONALD: I love that point.
ALAN HIGGINS: Yeah, it's a simple point. So, equities fundamentally are cheap on that relative value, because of the old Fed model, and I know a lot of people hate the Fed model. In fact, when I first started my career, when I started my career, I worked for Invesco. So, Invesco was in Atlanta as you know it, and Invesco in the UK. And they had a Fed model. And before the '87 market crash, to credit them, they got out of- they did the other way, the opposite of today's trade. They were buying IBM bonds at 10, 11. And selling equities on a dividend yield of two. And this is before you had buybacks. So, when equities are expensive, a loose Fed model, I learned from them- my colleagues in Atlanta. I was only a young 21, 22-year-old. Learned it and I thought this is really significant, that's really value driven.
Today, it's the opposite. Sell your corporate bonds and buy really attractive equities. And luckily, there's a buyback yield in the States. So, I started my career when bonds are with a value and I was a bond man. But now, as a bond man, always a bond man at my heart sitting here, equities is the place to be.
LARRY MCDONALD: Let's think about Europe and populism. In recent weeks, we've had VOX rise in Spain as a Populist Party that three, four years ago barely existed. In Germany, we have AFT, which makes Mr. Trump look like Mary Poppins on immigration. And they've gone from single digits to maybe 12 to 16%. Somewhere in there. In Italy, we have Mr. Salvini, who is rising like a rock star in the polls. But I want to concentrate on Italy and Mr. Salvini. We have EU parliamentary elections this month. We're seeing a rise from Nigel Farage, his Brexit Party. And the numbers are startling.
And some people are starting to say, okay, that's an early indicator for a populist score in May in the European parliamentary elections. And if there's a populist score in the European parliamentary elections, I want to focus on that third, fourth quarter, when you go into the budgets with France's deficits, Europe's actual budget deficit is on the rise. You have Italy in the same boat. The EU is- it looks like they're almost positioning to give France some wiggle room whereas they're coming down harder on Italy. How do you see that playing out in that third, fourth quarter in terms of setting up the budgets for the new year?
ALAN HIGGINS: I think that could set us up for a correction, I think you're right to be concerned about this. Is it enough to really get back on my thesis about equities? It was a longer-term thesis, clearly, you can't trade equities over a three to six months like that. But I think you're right. But I don't think it's enough to bring down the whole thesis because even Salvini is pro-business. Now, it'll be interesting to see in each of these countries that you're voting, just how pro-business that the various governments are going to be. I think where it does fall about fall apart, fundamentally, is if you get someone who's anti-business and extreme anti-business.
Now, we shall see. And, for example, could you have nationalization without compensation? That's certainly enough to really change my positive stance on equities. As for third quarter, fourth quarter, we are due to a wobble. And if you look at the trends, you and I have been in bonds for years, and we've seen Italy's debt has been high. Well, it started ridiculously high in 1992, right, through 1993. And it has edged up. To give Italy credit, they had tended to have