Interactive Investor

Peter Spiller: it’s like the 1960s! Half my portfolio is in this investment

Capital Gearing manager Peter Spiller, who has been managing the trust for more than 40 years, discusses where he's finding investment opportunities today.

6th December 2023 09:18

Sam Benstead from interactive investor

Capital Gearing manager Peter Spiller sits down with ii's Sam Benstead to discuss where he is finding investment opportunities today.

The veteran investor, who has been managing the trust for more than 40 years, explains that the current investing conditions remind him of the 1960s, which was a great period for one type of asset.

Spiller also gives a thorough overview of the economy and the biggest risks in markets today.

Capital Gearing (LSE:CGT) is one of ii's Super 60 investment ideas.

Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Peter Spiller, manager of the Capital Gearing Investment Trust. Peter, thank you very much for coming in.

Peter Spiller, manager of the Capital Gearing Investment Trust: It's good to be here. I should mention that I do not manage it on my own, I have very able help from Chris Goodyear, Alastair Laing, Emma Moriarty and Hasan Reza, who are quite a large team.

Sam Benstead: Team approach. But you've been on the trust for more than 40 years now.

Peter Spiller: That's true.

Sam Benstead: It's quite some time. So, how is investing today compared to those 40 years? What stands out for you in terms of opportunities and challenges?

Peter Spiller: Well, actually, the circumstances have changed a lot over that period. So, when I began in 1982, it was really a perfect menu for investors because the 1970s had purged balance sheets. The balance sheets were really strong and inflation was high, but falling. Interest rates were high but falling. And because of those interest rates and because of the experience in the 1970s, the price-to-earnings (P/E) ratio on the S&P 500 was about 7x. So, quite a long way away from where we are now. And, our approach then, was very much that when opportunities are good and risk is low, you should maximise the duration. And the converse when prospective returns are modest and risk is high, then you want short duration. So, back in 1982, we wanted very long duration, and the longest-duration asset is equities. And we had a lot of equities and they were great years.

But if we fast forward, perhaps I won't go through the whole history, but to the late 1990s, we were seeing equity valuations very high and clearly very risky. And essentially a bubble was going on. And then particularly, you recall, in tech stocks. And so we were very wary. But, fortunately, there were other parts of the financial markets, which were very attractive. So, interest rates were very high. We could have 4% real on offer in a lot of markets, and that look extremely good.

So, we had obviously, in line with that principle of having long duration where the risk is low and the return high, plenty of things like seven-year Bunds. So, happily, we sailed through that recession. And I have to say that era is the one that is closest to where we are now. So, we've got very high valuations. On a Shiller basis, the P/E in the US is about 30. We have an economy, which we might come on to, that is very fragile in our view. But there are plenty of opportunities as well.

Sam Benstead: And so how are you positioned today? What is that split between stocks and bonds, for example?

Peter Spiller: Well, it is low in equities as it has ever been. So, we have about 45% to 46% in index-linked bonds because the values there are fabulous in our view. We have about 12% or 13% in short-term credit, where we think the real yields are very attractive and should produce something like, in nominal terms, a little over 7%. Then, we have another 12% or so that's in very short government paper, Treasury Bills, that kind of thing. And they yield typically 5.5%, that sort of thing.

And then we have about 26% in what we call risk assets. So, 26% in risk assets, of which slightly over half are actual equities. The rest are what are generally known as alternatives, so that would be renewable infrastructure, core infrastructure, both of which we might come back and discuss, but offer very good real returns. And within the 14% or so that is in normal equities, we have big overweights to Japan and to the UK, both of which look as if they offer very good prospective returns, and very little actually in the US.

Sam Benstead: So, let's break into your positions then. So, almost half in inflation-linked bonds, why is that such an attractive place to be invested today?

Peter Spiller: Well, I think we just have to, Sam, go back to the economy. What we are experiencing now is a result of nearly a quarter of a century of very accommodative monetary policy. And what more might be likely called experimental monetary policy in the last 10 years is zero-interest rates and QE. I'm always reminded of [Ben] Bernanke's statement that the thing about QE is that it works in practice, but not in theory. And I think the second half of that statement is the one that will endure.

So, the result of that monetary policy has been a massive misallocation of capital. And the reason why it could happen, and it is worth emphasising, was that the admission of China into the global trading system produced such powerful deflationary force that it didn't really matter what you did, how loose you were, you could still get a result which didn't include a lot of inflation.

So poor Liz Truss if she'd been there, and done what she did four years before, probably would have been fine, but definitely wasn't by the time she did. And so, the result of that is that debt has built up to alarming levels, the highest it's been outside of war. But, so we’ve got just under 300% of debt GDP ratio in the US, 333% in France. These are alarming numbers, but debt levels haven't really changed in the last several years.

So, the markets got very used to it and isn't alarmed by it. So, one of the things we've had to look at is what is it that makes that fragile structure break? And the answer is either higher interest rates or recession, or obviously both. So governments continue to indulge in very high fiscal deficits. And that reminds me of where we were in the 1960s when inflation, in the middle of the 1960s, was quiescent.

It fluctuated over the previous five years between 0 and 1.5%. But by the end of the 60s it had built in the United States to about six. And that was because of persistent overstimulation by fiscal deficits applied to an economy that was already fully employed. And I think that's very much the situation that we are in today.

And we have deficits in excess of 6% of GDP. Thus, I think both parties in America recognise are too high. But there is absolutely no consensus about how they should be brought down. Certainly no appetite for increased taxes and certainly no appetite for cutting expenditure. So, we just get these large deficits.

That is causing a real problem with supply and demand for bonds, for Treasury bonds, because the Treasury bond market is currently about $33.7 trillion and about $10 trillion of that needs to be refinanced in the coming year. You add to that the $2 trillion that the budget deficit requires and a further $1 trillion for QT and the market has to come up with $13 trillion, the market being either investors in the United States or from overseas, obviously.

And we're about a year away from the Liz Truss debacle when markets lost confidence in the budget system and felt that the borrowing was getting out of control and that sort-of violent repricing and steepening of the yield curve. Corrected, of course, when she left office and [Jeremy] Hunt came in and so forth. But there was just a hint of that a couple of weeks ago when the American treasury market, 10-year treasury market, went through 5%. And that was largely in response to fears of the kind that I just laid out for supply and demand.

Since then, we've had a quite powerful reaction by the Fed in a number of ways. First of all, they orchestrated a large number of dovish speeches by members of the Federal Reserve Board. Just yesterday, Jay Powell hinted very strongly that he's not going to raise rates anymore. And the Treasury has announced that they are selling less long bonds. So that's a classic way to, I have to say, to a concerning balance sheet for the Treasury where the borrowing is all short, just means you have to borrow more every year, or refinance more every year. And that's seen actually quite a big rally. So, we've gone from 5% down to 4.7%, and so that's been great. But we don't think the problem is gone away. So, we'll see.

But we certainly believe that that period which I referred to earlier, where the forces of deflation were so powerful that you just didn't have to worry about inflation in the Western economies, and we’re actually going back to what's normal. So, what was normal was the post-war period. And in my very early experience in the 1960s, you had business cycles as opposed to the Great Moderation. You have inflation that goes up and down with those business cycles. And the average of those inflation numbers, we suspect will be significantly higher than the 2% target.

So, with that as background, and as a very fragile market, I won’tgo too much into the big threat to that structure, which is recession, so higher interest rates will be very damaging and so would recession. In the circumstances, to be offered a guaranteed 2.5% real return is just wonderful. And that is what the TIPS market offers in the United States, because it's just so low risk and it's a return which we think will be higher than the equity market going forward.

In the UK, there's a similar situation. So, yields aren't quite as high. They basically vary from 1.25% to 1.6% real, but with nice low coupons, individuals who own these instruments get, even if they're higher-rate taxpayers, an after-tax return that is only basically 20 basis points less than that.

So once again, a very secure reasonable rate of return without having to worry about anything. And in circumstances where the fragility of the economy might produce very strong negative returns in other assets.

Sam Benstead: Peter, it's been amazing having you in. That's all we've got time for. But thank you very much.

Peter Spiller: Sam. thank you.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can, like, comment, and subscribe. See you next time.

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