Wealth Management: Strategy blog – New Year Irresolution
Strategy team - Kevin Gardiner and Victor Balfour (Wealth Management)
Happy 2019! As if.
Below-trend business surveys from China, Apple's trading statement, the yen's surge, a further yield curve flattening - in some segments, outright inversion - and a big fall in US business confidence have quickly tested the US stock market's tentative new year resolution.
It doesn't take much to make economists gloomy. The guys who believe the world went ex-growth when the US left the gold standard - and that stock valuations also need to return to the 1970s - are letting us know, again, that they told us so.
Meanwhile, the US government is partially closed, “smocking guns” are encroaching further up Pennsylvania Avenue, the China-US tariff truce is fragile, France is the new Italy, and Brexit… well, enough said: our favourite holiday quote was from a UK circus clown complaining about being compared to politicians.
As we see things, China's economy is still slowing, not imploding, and the government has hinted at further fiscal expansion to come if needed. Elsewhere, 'hard' economic indicators such as retail spending, industrial output or hiring are not yet pointing to a looming big recession in the US or Europe. The yield curve's timing is fallible - particularly if QE distortions are still lingering. And sustainable growth did not depart with the dollar's gold peg. A geopolitical disaster is not inevitable.
Valuations did not look alarming to us at the highs. If estimates of US operating earnings for 2019 are roughly 10% too optimistic, so that we get an earnings standstill rather than a slowdown (the likely growth rate in 2018 was around 25%), the forward multiple is a far-from-outlandish 16x. The cyclically-adjusted PE ratio, the permabears' favourite, is heading for trend levels by year-end - with US real interest rates still subdued. These are still not 'cheap' levels - but we're not yet convinced they need to be.
It does sometimes feel as if the trading dynamics in the US stock market - and perhaps in the currency markets, given the yen's move - have been subtly altered in recent years, whether by algorithmic and high frequency trading or something else. We also wonder whether the recent surge in derivative prices (as per the VIX) is less marked than the sell-off in the cash market would usually warrant. The dollar's weakness is another unusual correlation (it is often a safe haven in noisy markets).
But overall, we see current concerns as signaling that the 'wall of worry' is alive and well: it often is, without lasting damage being done to portfolios. It won't be possible to prove that the world is not about to end until it hasn't (of course, it always might) - which may be too late to be useful to us as investors.
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