Past the peak?

We wrote last week how we observe that – after the recent correction – stock markets now appear to have entered a consolidation phase, expressed by an unwillingness to rally despite daily announcements of exceptionally strong corporate profit growth. This reached an average annual rate of over 23% in the US this week. We concluded that this may well be because investors are finally coming to notice that global growth is no longer accelerating further and therefore the highest earnings growth levels may also be behind us.

Whether this means that we are past the peak of this very long economic cycle and have entered a terminal downward slope or just experiencing yet another mini cycle within the much larger cycle cannot be determined at the moment. What is mostly consensus, however, is that there are no particular recession indicators on the horizon as there were at the end of 2015, which would point towards a mini cycle.

During this week’s Tatton investment committee meetings we took a very extensive look at all the indicators that we and our research providers observe and debated at length what implications the emerging picture should have for the most appropriate positioning of our investors’ portfolios.

In this article Tatton’s head of research, Jim Kean, will therefore present the larger picture we observe and do his best to translate it into a narrative that is accessible to our wider readership.

2017 will be remembered as the year when regional growth became the most synchronised in history. Given that global growth at an aggregate level had been improving for over ten years, this is perhaps surprising. One might have expected that economies would reach limits of capital and productivity at different times which would lead to growing dispersion.

However, it looks like such dispersion may well have prevailed 18 months ago as we headed into 2016, when emerging markets, and China particularly, hit a decidedly icy stretch of road. The deflation of the commodity bubble, a strong US-$ and a slowing economy in China had led to a substantial slowing of global trade.

China’s early response to weakness in 2015-16 had been to encourage a weaker Renminbi (devaluation). This had bad impacts, with residents trying to get their money out of the country, while Chinese companies that had borrowed in dollars faced increasing financial burden.  The end of 2016 saw the Chinese leadership change their focus, easing monetary and fiscal policy, but wanting to stabilise the Renminbi. This shift markedly improved demand for commodities, while easing dollar liquidity.

Trump’s arrival was the other major event of 2016. His policy mix – fiscal looseness, deregulation, and pressure on trade partners – may not have been obviously beneficial for 2017. However, the delays in fiscal measures meant that while the Fed tightened, it did not do so in a way which caused overall financial conditions to tighten. Personal (i.e. retail investor / consumer) sentiment was strong, leading to an oddity – retail investors increased their risk allocations, and equities saw large inflows. Equity prices rose and, helped by affordable but rising house prices, personal balance sheets improved, which meant that improving wages were channelled into spending. Indeed, the savings rate declined to historic lows.

Meanwhile Trump’s trade policy shift did not result in tariffs immediately. Rather, it was in the interests of both China and the US to see trade improvement through a weaker dollar.  Having expected speedy US company repatriation of overseas earnings, it became apparent that this would be more closely tied to tax changes later. Perhaps more importantly the dollar had reached very expensive levels when measured by “purchasing power parity”. In other words, you could buy more with Euros, Yen and Renminbi than with dollars. The dollar proceeded to weaken throughout 2017.

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