Dubai: Founded in 1999, CQS is a $14 billion (Dh51.42 billion) global multi-strategy asset management firm with over 260 staff located globally, 88 of whom are specialist investment professionals.
CQS launched its first fund in March 2000 and has expanded its offering to include additional strategies and bespoke solutions in the areas of multi-strategy, convertibles, asset backed securities, credit, loans and equities.
In an interview with Gulf News Sir Michael Hintze, Chief Executive and Senior Investment Officer of CQS presents an update on the risks and opportunities he sees in markets as we enter the fourth quarter of 2014.
Gulf News: How do you see the global investment environment as we enter the fourth quarter of 2014?
Sir Michael Hintze: I sense we may be at a potential crossroads for markets. While on balance, markets may be driven higher as central bank liquidity continues to be supportive and any tightening of US and UK monetary policy is likely to be measured, there is greater uncertainty and the effect of ‘surprises’ will be amplified, potentially leading to greater turbulence (or ‘pot holes’) across markets.
Q. Looking globally, how do you see developments in the economy and the geopolitical environment?
A. Again, there are a number of opposing forces. In the US and the UK, GDP growth looks firm, job creation is strong, and central banks are beginning to tilt towards a more hawkish stance; whereas in most of the European Union, GDP growth has stalled at low levels, with the ECB concerned about the Eurozone falling back into recession and deflationary forces. In Asia, India continues to grow strongly and China’s GDP growth looks to have stabilised at around the 5 per cent to 7 per cent rate, while in Japan, the jury is out about the effectiveness of Abe’s Third Arrow (structural reform). Geopolitical risk is high with the political unrest in the Middle East and the growing discord between Russia and the West around the Ukraine issue. Let’s not forget other parts of the globe including the South and East China Seas, tensions between the Koreas, Africa, the Ebola outbreak, and so on it goes. It’s an increasingly uncertain world.
Q. You have in the past spoken about the potential for a ‘black hole’ event on the horizon. Can you elaborate?
A. There are many potential sources of instability. US monetary tightening is one such risk. Others are more in the geopolitical arena and there are many, including the spread of Ebola in West Africa and beyond which clearly has the potential to escalate, as well as the South and East China Seas and China Shadow Banking that I have discussed in the past. But let me focus on two; the Levant and the Ukraine/Russia.
My focus is on the contagion risk of a geopolitical event. By contagion risk, I mean the potential for ‘leakage’ of such an event into the global financial system. You can have horrible and tragic things happening, and sadly they do all too frequently, but they do not transmit into the global financial system.
Q. So what could trigger substantial market instability from a geopolitical standpoint?
A. What I am most concerned with presently is an escalation of European Union (EU) sanctions against Russia. The EU, rather than the United States (US), is the key here. At the end of Q1 2014, EU imports from Russia were in the region of $292 billion and exports to Russia from the EU around $169 billion; the numbers for the US were, respectively $27 billion and $11 billion. My concern is that escalation of sanctions could affect Russian state-owned enterprises and the broader financial system. This contagion could threaten not only trade but trade finance and bank balance sheets.
Q. Looking specifically at the UAE, what is your outlook?
A. The IMF outlook for GDP growth in the UAE remains positive at 4.5 per cent in 2014 and 2015. We continue to monitor the region as we see the ongoing transition of economic reliance, in particular in the Emirates, away from energy production and into complementary sectors such as hospitality, aviation and infrastructure over the years. On this basis I see no reason why the IMF’s forecast is not achievable.
Q. Obviously the region is heavily reliant on energy production. What is your outlook for oil producing countries, such as those in the GCC, following the recent drop in oil price?
A. In the global economy we are seeing deflationary pressures with commodities, especially oil prices, on a downward trajectory. In addition to China’s growth rate moderating, the US is also producing hydrocarbons at significantly lower prices. There are both cyclical and structural forces at work here. This clearly benefits economies that are net oil importers and there will be challenges for energy exporters, such as those in the GCC, if prices remain low.
Typically, in commodities it’s the marginal cost of production that is the driving force for price. However, that is for corporates. The challenge for oil producing countries and regions is the break even price of production. Within Opec the estimated break even oil price for 2014 government budgets varies dramatically. By way of example, that estimated break even price is $140 for Iran, $65 for Qatar, and $70 and $75 for the UAE and Kuwait, respectively. Importantly, Saudi Arabia’s is estimated to be $93. This is in the context of a sub-$90 Brent crude price. For countries, such as those in the GCC, a persistently low oil price could affect their ability to maintain domestic infrastructure and in the long-term could be a force for geopolitical instability.
Q. Are you concerned about the course of US monetary policy?
A. Yes. I think markets are still somewhat complacent about a potential US tightening. The US unemployment rate is falling and, in my view, market participants underestimate the potential effect of a more restrictive US monetary policy in the medium-term.
If unemployment rate proves to be correct (5.9 per cent at the end of 2014 and 5.4 per cent at the end of 2015), the Fed is now close to its employment mandate. Add to this an inflation rate that is above market expectations in the US, and I believe rates can rise sooner than expected, especially at the long-end. However, it is a very technical situation with Fed Governor Yellen in the driving seat and I believe the Fed will be behind the curve.
Q. In light of the above, how do you believe investors should be positioning themselves?
A. As mentioned, I believe we should expect more market volatility. In such an environment, arbitrage and long/short strategies should benefit. Greater volatility and dispersion should also present us with more active trading opportunities. I also believe floating rate and shorter duration assets such as European senior secured loans and asset-backed securities continue to be attractive. In my view, a lot of the growth in China has been driven by the People Bank of China’s balance sheet expansion and it’s not clear how much further it can be prudently expanded.
More broadly, economies dependent upon China for growth may see a moderation of their economic growth and potential weakening of currencies against the US dollar, and corporates will see shifts in the pattern of demand for goods and services.
I think the US dollar will continue to appreciate against most major currencies due to the end of Quantitative Easing, the potential for tightening and the fact that it remains the global reserve currency.
