The Big Picture: Debt, growth and rates’ abnormal relationships creating abnormal conditions (Part II)

B. G., Opalesque Geneva

Patrick Welton

Dr. Patrick Welton Founder and Chief Investment Officer [email protected]

In this interview, Dr. Patrick Welton, founder and CIO of Welton Investment Partners, an alternative asset manager, offers his observations on the major macro themes expected to affect the markets in 2022.

In this final part, he talks about ESG standards and the rise of low carbon as an asset class in its own right. He also says the relationships between debt, growth and rates, a three-body problem, are now less stable than usual. Finally, he sees “pretty sharp tipping points” in the Chinese economy through the country’s unstable debt levels and its zero-Covid policy.

Click here to access Part I of the interview.

Opalesque: You say that ESG is one of the great macro investing themes in 2022 through 2042 and that carbon is in the process of separating into its own investing class. Could you elaborate?

Pat Welton: In the course of the last 18 months, while there has been a rise of ESG products everywhere, we see strong investor desire for specific low carbon asset class branching out from ESG.

Opalesque: Many managers are taking a step back from ESG products as there aren’t any recognised standards. What is your stand on this?

Pat Welton: We have developed our own ESG product stance with a rigorous ESG scoring framework. We have also pioneered taking ESG into multi-asset class for the return diversification and downside performance potential that multi-asset class investing can potentially provide.

Your observation on the lack of consistent standards is exactly the problem and the challenge for many investors. Serious questions abound: How do you measure it? What is the proper standard? Who is deciding? What is the source of information? Is it commercially sourced (and therefore does it have commercial motivations)? Is it NGO-sourced or world data sourced?

We have contributed to ESG improvements through our derivatives scoring papers, our new work on carbon, attributions to companies, modelling for companies that don’t report their carbon usage. Those are just a few examples.

In the ESG world, everybody has some sort of general agreement as to what is better or worse, but institutional investors crave measurements more than subjective improvements in the eye of the beholder.

Opalesque: According to you, the other biggest theme of this year is the three-body problem of debt, growth and rates. Please explain.

Pat Welton: Debt, growth and rates cover the classic terrain of macroeconomic relationships. When we are at these extreme levels of very low to zero interest rates, high convexity levels, negative real long-term rates, and high debt levels, many of the classic assumptions people rely upon to understand their causal and consequential relationships are at chaotic boundaries. Those relationships are less stable than normal. And secondary effects of investor reaction are imperfectly linked.

For instance, it is all too common that we will see, for instance, an announcement from central banks saying they are tightening, bonds will go up and rates will go down. Something that is counter-intuitive such as a large inflation report comes out and then investors move capital in a seemingly unexpected direction… The markets are the objective measure, of course, not the expectation. Investor reactions will be unstable to classic dynamic relationships until we return to classic levels.

The key take-away point is that traditional relationships are very hard to predict at these levels. We will need more intellectual flexibility. There are some abnormal relationships going on that create abnormal conditions for all of us investing on behalf of others. 2022 presents new world opportunities for potential profits and downside risk defeasance.

Opalesque: Your current view on China is that its opacity could spell trouble. Why?

Pat Welton: China is an economic miracle and a juggernaut. And, they are highly competent. The most predicted Covid outcome, for instance, is that the pandemic will be handled well.

But if Covid started to spread in the country and escaped public health officials’ ability to hold back, or if debt problems got out of hand even if they were being managed, risks could rapidly unfold. Because of the lack of transparency and information trust, global investors may have a different risk reaction behaviour. There is a risk of many outside investors selling first and asking questions later because they are not going to be sure what is truly happening.

The most likely outcome for the Chinese economy is a good one, but it could have pretty sharp tipping points.

Imagine what happens if large cities are shut down in an expanding sequence to prevent further virus spread; that will start a whole new wave in production-supply chain disruption which will fuel debt service concerns even further. These risks only rise with a virus variant like Omicron that is far more transmissible and poorly covered by the principle vaccines utilized in the country.

(Article reprinted with permission from Opalesque).

 

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