World markets at peak of anxiety

GLOBALLY, currencies and interest rates have already moved to factor in the new reality in China, says Charles Dallara, who is acknowledged as one of the most astute and widely experienced ‘insiders’ of the world financial system. In this exclusive interview with ATI Magazine, Dallara says that, globally, currencies and interest rates have already moved to factor in the new reality in China. “Markets may over-react at times,” he observes, adding that, basically, the global economy is resilient . . .

WITH SPOT FIRES pringing up in many regions, the world appears an unnerving place today.
But the reality is, perhaps, not as glum as some believe, according to Charles Dallara, who has the clarity of mind — as long-term investors must have — to cut through the static and discern the facts from perceptions.
The world is not a cauldron of turmoil, assures Dallara, a Partner and Chairman of the Americas at Partners Group Holdings, based in Zug, Switzerland, and custodian of some US$47.5 billion of funds under its charge.
But while he does not believe there are reasons to despair, he urges governments to think about changes to their tax policies — for example, to encourage renewal of ageing infrastructure and  to remove artificial incentives on real estate investment — to deliver sustainable growth.
Dallara told ATI during a visit to Sydney: “Markets are not always good at separating their sources of anxiety. In the last few weeks, we have had four or five different sources of anxiety running together.”
These issues are:  China’s slowing economy and its stock market; the oil and energy market; concern about emerging markets; the Greek debacle and continuing clouds over the European economy; and, finally, the uncertainty of US interest rates and US monetary policy. “Coming together, the five forces have created a peak of anxiety. But if you deal with each of them individually, they don’t present a cauldron of turmoil. They present challenges for the global economy, each in its own way manageable.”
Dallara is someone who has been in the eye of global financial storms many times. He played a pivotal role in the Plaza Accord, which has just celebrated its 30th anniversary as one of the most successful attempts at macro-economic  co-ordination in modern history. The Accord helped bring down an overvalued dollar and control protectionist pressures in the US.
Dallara also played a central role in the Brady Plan, which successfully addressed the Latin  America debt problems of the 1980s.  
More recently, he was Managing Director of the Washington-based Institute of International Finance, the peak global association for financial institutions, during the dark days of the Lehman collapse in 2008. Then in 2011, he co-chaired negotiations between global banks and Greece in the largest debt restructuring in history.
On China, he says the lesson of the recent share market rout is for China not to attempt to preserve artificial values, but instead to enhance its accounting and auditing standards to bring more liquidity, better transparency and depth into the markets.
“The Chinese leadership appears to be taking away the right lessons from this,” he says. “Most observers knew that Chinese markets were not yet mature. It is unfortunate that too many Chinese citizens used leverage and margin arrangements, but this does not have the potential to create a huge problem for the Chinese economy.”
Dallara says Chinese growth peaked at 10 per cent after the crisis in 2010, and it will continue to slow as the economy undergoes its transition from export-driven to consumer-and-services driven. “We should get comfortable with that, and the Chinese leadership needs to get comfortable with the fact that there is nothing magical about 7.0 or 8.0 per cent growth. It doesn’t help to create the image that there is a big line that they can draw at 7.0 per cent.
“The world will continue to benefit if China grows at 6.0 or 6.5 per cent or even somewhat lower growth rates as we move into the second half of the decade.”
Dallara understands China’s lower growth is of concern to Australia, yet much of this has already played into the markets — with lower iron ore prices and a weaker Australian dollar.
Globally, currencies and interest rates have already moved to factor in the new reality in China. “Markets may over-react at times,” he observes, adding that, basically, the global economy is resilient.
On energy prices: “They have led to some painful adjustment in energy-producing countries, including the US where, of course, much investment has been put on hold.  But there is an upside to this as well. Globally, energy
products are much more affordable and certainly this will boost consumption.”
On Europe: “It was a calamitous, chaotic summer. Things have temporarily calmed down. Unfortunately, very little has been done to resolve the Greek debt problem because they have pushed the debt issue off into the future.  I am afraid the kind of reforms that the Greek economy needs are still not being pursued with adequate vigour. ”
On US interest rates: “The Federal Reserve is on the edge of lifting interest rates. The world has been expecting it for so long.  I am reasonably confident that, perhaps after a period of volatility, the world will adapt quite
effectively to higher US interest rates.  Much of that has already played out in the market.”
Dallara adds, however that the concern is not about the first move, rather, about subsequent rate rises. Dallara says “broad market sentiment” sees only one move in the fourth quarter of 2015 — and then one or two moves in the first half of 2016. “Of course the Fed will tell you it is very data dependent and they are going to watch how the market and the economy react before making the next move.”
On the US economy:  “For so many years, you could wake up one day feeling the glass was full and then you wake up the next day with the glass half empty — this was the way the US economy felt for much of 2012–14.
“However, ambivalence about the US eco-nomy is gradually fading. Yes, there are still weaknesses, and question marks on many issues — lack of corporate investment, middle-income rising too slowly, the strength of the dollar — but these are now smaller question marks.
“The US has seen steady creation of jobs — about 150,000–200,000 a month — and jobs growth has placed an underpinning on consumer confidence and, to a certain lesser extent, investor confidence. That will sustain growth most likely in the 2.5 per cent range.
“We have sufficient momentum and we can weather the headwinds of a strong dollar and some of the other factors. The US economy is now more resilient.”
On currencies: Dallara says the strengthening of the dollar has run most of its course. If he was pushed to predict, he tips that the greenback possibly will see another 10 per cent rise on a trade-weighted basis a year from now. Similarly, he agrees that, potentially, individual currencies like the euro, the Canadian or the Australian dollar may face further movements, but he describes China’s devaluation as “the greatest non-event”.
On job creation: “China created 13 million job in urban centres. The US is creating jobs, and parts of Europe are also creating jobs. I would admit that, over the medium term we have the technological challenge to create sufficient jobs in the world. Technology is increasingly pulling us towards investing in capital rather than investing in labour, but if we are creative enough, there is scope for job creation.
“I am not much of a pessimist. We are continuing to benefit from this astounding technological revolution, but it will require some conscious plan and thought to make sure we continue to create jobs in this environment.”
Dallara says jobs are being created in the service sectors, such as healthcare, financial services and hospitality. In time, these sectors will become an important part of the US and Chinese economies — just as they are in Australia.
In 2013, the global private markets investment manager, Partners Group, brought Dallara, who is globally one of the most recognised authorities in the financial services industry, into the firm’s top echelon of executives to share his experience and contacts.
So how does Dallara, the investor and asset manager, perceive the risks and rewards in this uncertain world?
“One of the lessons I have learned is that good private investors can see through macro-economic weakness to find good value opportunity. And this is something Partners Group really prides itself on,” he says, adding that
investment decisions are made with exchange rates, hedging costs and corruption or eco-nomic inefficiencies in mind.
“We have a very clear philosophy here — our relative value philosophy, which means we constantly search the world for a discounted relative value opportunity or opportunities to create value over time.”
Dallara says the firm has channelled much of its equity investment in the last two years into the US and Europe, but the search for opportunities extends to Asia, Latin America and the Middle East. The Partners Group has the world well-covered with a network of offices in key markets. “You can find good entrepreneurs in virtually every corner of the world. If they have a good solid business model and we are confident that we can create value over 3-7 years, these present interesting opportunities.”
The Partners Group has looked at healthcare and early childhood education as two sectors with the best promise for growth. Dallara describes them as secular investments which can lean against the wind in a world of cyclical vulnerabilities.
In February 2014, the Swiss group teamed with Starr Investment Holdings to acquire the US health insurance claims processor, MultiPlan Inc, for US$4.4 billon, followed by its purchase of early-childhood education operator, KinderCare, in a deal believed to be worth US$1.5 billion this year.
“As soon as we are engaged in due diligence to consider buying a company, we ask ourselves what kind of value can we create here?  And this is where our global network comes in handy.  We bought a company, Universal Services of America, and over a two-year period completed 27 acquisitions, then exited the deal at a multiple of 2.9 times. So we are not blind acquisitors.”
As is the case with Universal Services, which existed in a fragmented security industry, Dallara says the early childhood education sector is equally fragmented. The new owner intends to grow the KinderCare business through acquisition and consolidation.
In an uncertain world, the challenge for long-term investors is to have the eye for the right opportunities.