As we move into 2018, the ‘end of the cycle’ has become the dominant topic for the investment community. After 10 years of both markets and the real economy trending upwards (though only recently has the economy been strong), some fear that things will head the other way soon. However, our central case for next year is that the global economy will continue to move forward, even though capital markets may be entering some choppy waters.
Let’s start with a recap. Investment returns were overwhelmingly positive over 2017, as markets shook off worries at the beginning of the year to end near or on record highs. Despite global central bank policy starting to become less easy, the spare liquidity available to investors (termed “financial conditions”) increased sharply and sloshed towards assets – equities in particular – producing very healthy returns with historically low volatility.
This boom in the financial economy has been backed up by solid real economic growth., and we end 2017 at a very strong level. Goldman Sach’s December estimate for current global growth is 3.7%, the strongest since 2006. Employment rose and confidence generally went up. In this strong picture, the surprise was that inflation stayed low, apart from the UK. That’s one reason why the UK performance lagged the rest.
Everything going so smoothly has led many to suspect it’s the calm before the storm. This is understandable; post-war economic cycle lengths have averaged about six years while investment returns have tended to see flat-to-bad years follow a couple of good and vice versa. But cycles don’t die of old age. Without some dynamic causing a downward shift, it’s reasonable to expect that the global economy will continue to move forward even as the current cycle enters its tenth year. So, what could bring the party to an end?
In our view, the two factors that could cause a slowdown in 2018 are a fall in consumer confidence and the continued effects of quantitative tightening (QT). If the former happens, it is likely to be in those regions where wage growth is low, consumers have already expanded their debt and – such as in the US and the UK – traditional businesses face yet more pressure from tech-based competition.
The rise in employment this year has brought a large number of people’s spending power up. But as we hit “full” employment, the rate of employee growth slows. At this stage, one would expect wages to rise more quickly. But so far, in most regions, it hasn’t happened to any extent. In our discussions with many analysts, we would characterise the consensus view on wage growth acceleration as “it hasn’t yet happened but it will”. We disagree with this view, and think that, if it was going to happen, it should have happened already. Structural issues in certain economies (Brexit in the UK and labour market issues in the US, which we’ll cover more later) are the main constraint.
