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Donkey's years

28 November 2018

The current run of growth may feel long in the tooth, but that doesn't mean it's over, or that investors aren't finding select opportunities.

Nothing scares seasoned investors like things going well. After all, history suggests that, at some point, something will go wrong.

And things have been largely going well for quite some time. The global economy is growing at a healthy pace, led by a resurgent US economy that is forecast to expand by more than 3% this year. Moreover, in March 2019, the current bull run will reach its tenth anniversary. The S&P 500, despite a couple of corrections this year, has more than quadrupled in value since its 2009 low.1

Yet there are also headwinds to contend with: rising US interest rates; growing trade protectionism; the petering out of Donald Trump’s 2017 tax cuts boost; slowing Chinese growth; Brexit; and Italy’s budgetary dispute with the EU. Investors inclined to see the negatives might be tempted to echo the sentiments of Eeyore, the depressive donkey in Winnie the Pooh: “End of the road. Nothing to do, and no hope of things getting better.”

So, has the expansion run out of road?

“2018 has seen extreme momentum picking up very quickly and then moderating somewhat, but we think the consensus is now more pessimistic than is justified,” says Wei Li, Head of Investment Strategy at Blackrock. “Our own growth indicators show some positive trends and so we are more pro-risk than some other investors, because we think that there is more growth to come. We’re not about to pick up the same trajectory as we had at the end of 2017 but there’s still upside. We also believe that companies are yet to get to the peak of corporate earnings.”

She is not alone in her analysis. Loomis Sayles, manager of the St. James’s Place Investment Grade Corporate Bond fund, forecasts 3.7% global growth in both 2018 and 2019. Sarlo argues that many of the best investment opportunities will henceforth derive from the fact the economic cycle has entered a late stage.

“In the expansion to late cycle, when economic activity has been going on for some time, inflation risks tilt more to the upside than the downside – and the central bank leans against that,” says Laura Sarlo, fund manager and Senior Sovereign analyst at Loomis Sayles. “It tends to be a pretty good time for stocks and maybe a less good time for bonds, given the interest rate increases. Our base case is that the economy is mostly okay.”

Dig deeper into that analysis, however, and Sarlo points out that the growth outlook is increasingly differentiated by region. Thus, growth in Europe has been slowing even as US growth has been strengthening, thanks in part to Donald Trump’s tax cuts package – although it comes with strings attached.

“The fiscal expansion is adding about 0.4 percentage points to growth this year and should add 0.2 points to growth next year,” says Sarlo. “It’s being funded by debt, and so the deficit will be around 4% this year and 5% next year.”

Treasury yields – recession predictor?

In fact, debt more broadly is one of the main reasons some investors are nervous. Many of these fears coalesce around the Treasury yield curve – the line on a graph which shows the yield offered by different US Treasury maturities. Put simply, when long-term debt offers a lower yield than short-term debt, it has traditionally been a reliable predictor of a recession. In recent months, it has been heading in just that direction – does that mean a recession in the US?

“We think this time is different from previous market cycles because, during periods of ultra-loose monetary policy, there is a lot of demand for higher yielding assets,” says Blackrock’s Wei Li.

While every cycle comes to an end eventually, Wei believes the current one isn’t done yet – and that its remaining run should be measured in years, not months.

“We still see spare capacity and believe the US economy can grow for an extended period of time,” she says. “But after the larger-than-expected fiscal stimulus and tax cuts, it may have shortened slightly. We may have another 12 to 18 months before we have to start thinking about recession and what it might mean for asset allocation.”

Wei is not alone in sensing danger in Donald Trump’s 2017 package of tax cuts. While they have offered a short-term boost, they are certainly not out of the standard economic playbook.

“Trump’s fiscal policy stimulus is the US’s largest fiscal policy stimulus outside of war times, and is a significant policy error,” says Neil Woodford of Woodford Investment Management, manager of the St. James’s Place UK Equity and UK High Income funds. “Everyone is enjoying the sugar rush at the moment and tax cuts have obviously flattered corporate earnings, but we should see more interest rate rises as the Fed begins to worry about the inflationary consequences from this mistimed stimulus. That would push up the dollar and hurt several emerging markets, so there are some big headwinds out there next year.”

Yet those headwinds are not necessarily universal, and some of the best opportunities may yet be in the most unloved markets, not least the UK.

“The UK right now is one of the most attractive opportunities I have seen in my 30-year career,” says Woodford. “It’s an asset class that has attained pariah status on a level no other class globally appears to have attained. Everyone is running away from it at the moment and the reason is that people are not looking at it rationally. But in the end, of course, value is always realised.”

 

Blackrock, Loomis Sayles and Woodford are fund managers for St. James's Place.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The opinions expressed are those of Blackrock, Loomis Sayles and Woodford and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or adopt a strategy. The views are not necessarily shared by other investment managers or St. James’s Place Wealth Management.

© S&P Dow Jones LLC 2018; all rights reserved

1 Source: Bloomberg

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