Peter Spiller: the biggest risks for markets in 2022

Peter Spiller, fund manager of Capital Gearing, names the main risks that will keep markets and investors on their toes in 2022. Spiller also gives his view on markets, pointing out “there’s always potential for correction when you’ve got valuations this high”. In addition, he explains why the trust has a small investment in gold.

Kyle Caldwell, collectives editor at interactive investor: Hello, today I'm joined by Peter Spiller, fund manager of the Capital Gearing (LSE:CGT) investment trust. 

Heading into 2022, are high inflation levels and the potential interest rate rises that may follow, the main risks that investors should be worrying about?

Peter Spiller, fund manager of Capital Gearing: I absolutely think they are. Because first of all we are less optimistic about inflation than the market is generally because, although we fully concede that a lot of the current levels of inflation are driven by shortages of one kind or another as the economies re-emerge from COVID, there is a real danger in our view that the current levels of increase get embedded in wage increases. And after that then we’re likely to see sustainably high inflation, which is after all, what central banks have been asking for, and hoping for, for quite a long time. I think they're going to get it, but they might get a little more of it than they really want.

So that means that we will see interest rate rises, I’m pretty sure of that. Incredibly to me, the American market is suggesting that interest rate rises will peak at somewhere less than 2%. Now that is an extraordinary statement to make, because it implies that negative interest rates will prevail for some time. And all the strategies for dealing with inflation involve high short-term real interest rates. So that suggests that the ability of the [Federal Reserve], and I believe the UK, to deal with inflation, is really very constrained. And they’re constrained because debt levels are so high. So obviously in the UK you could not see interest rates of 4%, for instance, without the housing market falling over and caused huge banking problems. 

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So I think the - it's going to be really tough for the central banks to deal with this. But it also means that this wonderful environment we've had for 30 years of inflation being kept down essentially by globalisation and demographics, but moving out of that area, that era is also characterised by a consistently stimulative monetary policy and very low interest rates. And it’s plain that those are going to be reversed to some extent at least. And that's a very different environment. So I think a much more volatile one. 

Now there is an issue about what matters, is it real interest rates or is it nominal interest rates for equities? And without going into a lot of detail, I think nominal will play a very big role, so I think they should worry about it. 

Kyle: And are there any other risks that concern you at all, that are perhaps a bit more under the radar that other investors are potentially not thinking about?

Peter: Right, well, I mean obviously related to the first point is this extraordinary level of debt that prevails. So how do you get house prices down from 8.5 times income, to something that could be sustained with a slightly higher interest rate? It's just going to be really tough. And as I say, I think debt is at levels which just requires higher inflation. Central banks I think will have to just live with it. 

The other thing is, I think it's not unknown, of course, but I do think the influence of climate change is going to be really important in the sense that vast sums are going to be spent on addressing it. And those sums will produce very little economic return, they’ll produce obviously environmental returns, but not economic returns. And I think that will be very inflationary. But also will make real growth quite difficult to achieve. 

Kyle: And what’s your outlook for markets in 2022? It’s been a pretty strong period for global markets in general, there’s not been a big market sell-off since the first quarter of 2020. And so do you think in 2022 a potential market correction may take place, and if there was a market sell-off, would you view that as a buying opportunity? 

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Peter: Right, so the first thing to say is there's always potential for correction when you've got valuations this high. One just has to accept that. 

There has been a view that the Fed will keep markets up, and that Fed 'Put' is definitely still there, so if they can, the Fed will stop the market being very weak, because they believe that it is their job not to have too tight financial conditions. And their definition of financial conditions includes a large slug of equities. So that by design, that Put is still there.

However, just to revert to the first point, if inflation is really a problem, then it's quite difficult for them to put that Put into operation. So my answer to you, you know, would you buy the dip, so to speak, is that potentially yes, but it’d have to be a very big dip, not the sort of thing we've seen in recent years. 

And the final point to make is that we really don't try and forecast what markets will do in the short term. So 2022 would not be our, you know, we don’t spend our time thinking about forecasting what market levels will be for instance. What we like to buy is value, and low risk value, and if opportunities crop up, then we certainly will always take advantage of them. 

But as for believing that the market itself, from this extraordinary level of valuation, so the value of equities in the United States, which is particularly the one that's overvalued, but private and public is 280% of GDP. The previous peak was 190% of GDP. It's a big difference. 

Kyle: The trust has 1% in gold, given the higher inflation levels that are expected next year, is this a position that you would consider increasing at all? 

Peter: Yes, well, we consider gold all the time. So as you say, the 1%  is really a token, isn't it? And that's because we, very quickly, the contention for gold is that it holds its real value. And we said, ‘Ok, let's look at what that real value is.’ So we took a base of August 1973, so that’s two years after Nixon closed the gold window, at a time when inflation was pretty rampant, and I'm pretty sure the free market price of gold was not depressed. We applied the CPI [inflation rate] in America to that and you get a number if you do that of under $600. 

So gold does indeed have attractions in times of inflation, particularly very high rates of inflation. But it's trading at a very big premium to that long-term value. And we find it much more satisfactory to own TIPS [Treasury Inflation-Protected Securities, or Bonds] because we can analyse TIPS, we know exactly what the return’s going to be, and we can make reasonably comfortable analysis, let’s say. But with gold, it's a psychological game, isn't it? So we are much less happy. 

The one time I would increase gold is if I thought there were circumstances where a substantial number of people, they might lose everything. So my favourite example is if there was political instability in China, for instance. Because when you might lose everything, as in times of war, when gold has traditionally done very well, you buy an asset without really caring whether it's going to hold its real value. It's just going to have some value. And the price of gold could be very high in those circumstances.

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Kyle: And finally, a question that we ask all fund managers that we interview, do you have skin in the game? 

Peter: OK, so not just I, but all the team here have essentially all our money, all our financial assets in our funds? With the trust, I have - it's a matter of public record. I have quite a substantial stake. And the theory we have is that the trust itself is very well diversified, you don't need to diversity outside of those funds. 

Kyle: Peter, thank you for your time today.

Peter: Not at all.