Craig Rippe: Why bears are wrong on the Shiller PE ratio

Canada Life Investments multi-asset manager tries not to call the end of the cycle too soon

Craig Rippe (pictured) has been gently reducing equity exposure across the Canada Life Investments multi-asset range as the cycle charges further into late-stage territory, but he is wary of missing out on returns by calling the end too soon.

And he’s not alone. Looking at his peer group, the head of multi-asset at Canada Life Investments notices that most funds have been reducing equity risk over the past couple of quarters.

“The reality is that late-cycle conditions can continue for one to three years, and if you call it too soon then you can miss out on significant returns,” says Rippe.

This thinking feeds through to the asset allocation decisions across the largely fettered LF Canlife portfolios. The problem he currently has is that there are very few suitable alternatives to equities.

Unfortunate choice between equities and bonds

The range is mildly overweight equities, slightly underweight fixed income and neutral on property. In fixed income, Rippe is overweight short-duration and in equities he favours the UK over global markets.

A 10-year bond yielding 1% in the UK against the unlikely prospect of significant rate changes is not appealing, says Rippe. “It’s negative real returns. Corporate bond yields are at quite tight spreads historically and we have a low gilt yield in relative terms. Unfortunately, we are in a late cycle for equities and very low returns for bonds. Those are your two main choices.”

Rippe is not predicting a recession any time soon, nor does he feel rate rises are on the cards. He also views the furore around US-China trade as noise and the current manifestation of rising tension as part of “the 100-year rise of China”, which we are about halfway though.

“We should not get too hung up on president Trump’s latest tweet but view it in the context of a general rising tension and hopefully we will keep it under control.”

Elsewhere on the geopolitical stage, Rippe looks to elections in the US next year as a potential dampener of tensions.

“Trump is going to want to be pulling some economic rabbits out of the hat in 2020 and will therefore be trying to delay good news from 2019 until 2020 if he can.”

Short-duration bonds as a cash proxy

That said, geopolitics is an important factor and has instilled a sense of caution when approaching asset allocation.

In the lower-risk portfolio, the LF Canlife Managed 0%-35% Fund, cash plays a part but Rippe has tried to avoid holding it generally across the range, preferring to access short-duration bonds as a cash proxy.

“The 0-35% fund has a high defensive tradition and we have been choosing to go into short-duration to produce a small yield pick-up of 70-100 basis points versus cash.

“Inflation is getting higher at the margins, so I don’t want to get a -2% real return on cash balance,” he says.

In terms of geographical exposure, Rippe says the range is overweight UK relative to its peer group, describing the domestic situation as “extremely revolting” owing to its cheapness because of Brexit.

“The market really doesn’t like it,” he says. “Everyone has been selling because of Brexit and because of sterling and, if anything, we’re probably contrarian on that and so we’re overweight UK versus our peer group.”

When it comes to domestic versus international earners, Rippe says both have their advantages and the trickier task is getting the market cap exposure right.

“The FTSE All-Share is about 85% FTSE 100, around 12% in mid-cap and 3% in smal-cap. You find it gets a bit awkward around the 12% mid-cap point. Some of that is quite illiquid and difficult to operate in.”

According to Rippe, the firm’s US equity manager is bearish on the region. “I can see why there are going to be tech headwinds. Some of the big tech has got ahead of itself and has too high a market share,” he says.

Rippe also fears big tech will face heightened regulatory measures and taxation down the line, which could hurt companies in this sector. However, that is likely to be “a gradual headwind rather than a gale”, he adds.

US valuations look heady, especially on a Shiller PE reading, which Rippe says the bears are getting excited about. “It has been a good indicator historically but, as interest rates get lower, mathematically the Shiller PE must go up, all else being equal.”

He says: “[It’s not often mentioned that the] Shiller PE is a 10-year earnings cycle and 2009 and 2010 were dominated by huge losses in the banking system. They will drop out of that calculation in the next two years, meaning it’s going to look cheaper.”

Rippe caveats that a lot of debt has been taken on by corporates in the US, which could cause issues if there is a downturn in earnings, although he is relaxed about that.

Europe needs to sort itself out over next decade

Elsewhere, the team is not overly excited about Europe, given the uncertainty surrounding upcoming elections and the fact its two superpowers, France and Germany, seem to be at odds with each other on policy, making leadership unclear.

That’s before the financial tension in Italy is factored in.

“I am not forecasting that the problems will happen any time soon but I think they do have to be resolved in the next decade or so. In the meantime, growth out of Europe is very desultory.

“The valuation is cheap and there’s nothing to get me too excited.”

Emerging markets on the other hand are interesting Rippe, but he is not prepared to allocate much capital to the region. The target is low, at 1-3%, as the region is only a small proportion of the overall capital pool.

“There is a pocket of interest there because they have been underperforming until three months ago. They look quite cheap and are more uncorrelated to the other markets. If you’re looking for something different than emerging markets are always an interesting place to be.”

Property not currently an area of excitement

Property exposure has also suffered recently because retail has been lacklustre. The team remains neutral and is not hugely confident for the year ahead.

All the multi-asset funds access property through the LF Canlife UK Property authorised collective scheme (ACS), a UK-authorised tax transparent fund structure, which has exposure to retail as well as UK offices.

According to Rippe, this is showing no signs of being affected by Brexit.

The LF Canlife 0%-35% Fund has a 14% allocation to property while the recently launched LF Canlife 20%-60% Fund has a 12% allocation. The Canlife Balanced Fund has no exposure.

Speaking about adding property to the 20-60% fund, Rippe says: “We see it as a useful diversifying asset class over a period of time. We have access to a liquid, high-quality ACS here but I don’t see it as being exciting in the next 12 months.”

Switching out of active

Passive exposure is used for positions where active funds have not worked or where there is no in-house experience of managing a certain asset class or strategy. The team is currently reconsidering where it uses active managers.

“There is a debate as to whether we should be using actives but there’s a price impact from that decision and so it’s under review,” says Rippe. “There are some funds that we deem to be sub-scale and not working, and I’ve started switching out of those and you’ll see more action later this year.”

For now, though, Rippe will not be drawn on which funds are under consideration.

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