Especially if you’ve read The Pivot (exclusively available from www.jackandjill.ie) or any of our regular releases you’ll be familiar with the case that the unaddressed issue of excessive debt, fueled by over eight years of cheap money and extreme monetary policies, has created fresh bubbles throughout the global economy. This is hardly radical thinking and has been expounded by many writers in one guise or another. My view is that the point of sufficient reasonable doubt has been past for fresh investment at these prices, especially for those with less recovery time on life’s clock, and that it is time to review one’s overall balance sheet mix and to de-risk it, where elevated.
Attached is my last commentary ‘Has the Irrational Exuberance Phase Arrived?” Also to make the point that I’m not a perma-bear, attached is the transcript of TV3 AM Interview 2nd Feb 2009 when extreme pessimism stalked commentary, but swimming against the tide, I was pointing to reasons why I believed the pessimism to be overstated and why a rally in the USA was imminent. That rally began four weeks later and has continued to 2018. Viewpoints are, of course, founded by examining oftentimes, competing and confusing information and then making a judgement call. Nothing is certain. Viewpoints on the same facts can vary.
Below I outline the case for the glass being half full, the sum of the reasons why the optimistic view of rising stock markets and acceleration in global economic growth, forms the consensus. As we shortly enter the exit from extreme monetary policies and tightening interest rates needed to head off inflation, my view is that the risks of buying into equity and property markets at these prices generally isn’t counterbalanced by sufficient probability of being rewarded. In simple terms I think the glass is now half empty and the risks not worth it, which is why I’m slow to add too many risk assets to portfolios even for the long term.
As explored in The Pivot the bumps work out if assets are held long term but when risk assets are bought at inflated peaks, the time to recovery can stretch to very many years. Timing does matter.
So, what is driving the stock market Bulls?
- The evidence is emphatic that global growth is accelerating, that growth is synchronised because practically all economies are reporting it with the global rate expected to surprise to the upside, coming in at 3.4% for last year, up from the 3% expected thus marking 2009 to 2018 as the longest period of recovery since the end of World War Two.
- The recovery is reflected in stock market rises out of the deep trough at its lowest in March 2009 since which the broad measure of global stock markets is up two fold, the US and India up nearly fourfold and even the stable German DAX is up two and a half times its price at the trough. This is against the backdrop of global economic expansion of one third over the same period.
- Europe surprised positively and gathered strength in 2017 recording growth of 2.4% while unemployment across the region declined helping Europe to start to follow the virtuous circle of more jobs, more spending and more economic activity that has buoyed the USA.
- None of the main barriers to a continued bull in risk assets is expected. This includes a surprise acceleration in tightening of US interest rates that would be damaging to the economy, a recession in the US characterised by two back to back negative quarters, a surge in wage and consumer price inflation that would hurt corporate margins and finally, no irrational exuberance.
- In a prolonged period of disinflation (low inflation) and low interest rates, it is natural for economic recoveries to extend beyond historic norms and so the unusual calm in volatility, and which continues to dampen, is explainable. Low inflation has been prevalent for the past twenty years so it is nothing new.
- Low inflation is the new normal because of the impact of technology advances competing against labour and even in a tightening employment market this will continue to feature.
- Consumers have been deleveraging, reducing debt from pre-crisis highs and are now back spending savings, a crucial support for the US economy in particular where 70% is based on consumers spending.
- In terms of stock market prices, the environment is all set up for sustained growth in earnings by businesses and two thirds of the price rises can be traced to growth and dividends, just one third to rising prices for the same stock as investors are prepared to buy it at higher price to earnings ratios than before. Even so, at a time of low inflation and low interest rates, higher multiples can be expected.
- The Tax Cuts & Jobs Act of last month can be expected to add nearly $1.5 trillion to the US economy and isn’t outsized by historical interventions. It is the eighth biggest in one hundred years, expected to add an extra 0.3% growth to US GDP over this year and next.
- Everyone has concerns about China but a weaker US Dollar is thought to weaken capital outflows as well as internal tightening by the Chinese Government. The USD is likely to remain flat, against other currencies this year.
- Fixed Interest bonds are a crucial anchor in an asset mix but can be expected to produce negative returns as the interest rate tightens in the US. Tightening by the ECB is further away and unlikely until Quantitative Easing measures are tapered to close to nothing.
- In the US, inflationary concerns are leading to rising inflows to Inflation-Linked bonds whose price which is based on a forward-looking ten year inflation average of 2%, so it seems good value for ‘Linkers’ in that market.
If that’s the optimists case to pile into equities, even if the preferred spots are Europe, Japan and Emerging Markets (with Europe once again flagged as having the best upside due to relative cheapness), what are the risks to the glass half full analysis?
- Trump swaps cajoling China with hardening the US stance against unfair competition including currency manipulation to boost exports. This leads to the beginning of an economic struggle as the US attempts to reduce its trade deficit, 60% of which is to China.
- War with North Korea is an understated possibility despite occasional calm and which would lead to a devastating shock to the region and the world economy but even if no war erupts whether by accident or design, North Korea supplies its nuclear weapon technology to terrorists or their sponsors.
- Cyber-attacks escalate causing greater harm as new generation attacks are amplified by artificial intelligence gains and are aimed squarely at the global financial system.
- Putin’s Russia recommences its expansionary plans to counteract NATO encroachment leading to tensions with both the USA and Europe.
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