WE LOOK AT WHAT THIS MEANS AND WHERE WE BELIEVE WE ARE
Traditionally, the latter part of a cycle is characterised by rising real wages and higher consumer confidence, higher business confidence and investment, in turn leading to rising commodity prices and – on occasion – high and rising debt levels, the combination of which is often inflationary.
Today we do see some signs of late-cycle phenomena: unemployment is low and real wages are rising (although not as fast as they have historically), consumer confidence is high and retail spending (including autos) has been strong in developed markets. Business confidence has also been strong and debt levels have surpassed the 2007 highs. However, investment remains below expectations, commodity prices are weak, inflation remains broadly below central banks targets and economic growth is subdued. Indeed, we have even seen some early cycle market behaviour in the last 12 months, with value outperforming growth and interest rates rising on expectations of bumper growth. Clearly, then, where we are in the cycle is not clear.
The reason some believe we must be late cycle is because we have gone 8 years without a recession. However, as Leon Cooperman[1] has asserted, “bull markets do not die of old age, they die of excesses such as accelerating and above-trend economic growth, rapidly rising inflation and interest rate hikes from a hostile Federal Reserve”. We might add “unknown unknowns” (or “unexpected shock”) to that list.
Unknown unknowns are impossible to anticipate by definition, and we don’t see signs of accelerating above trend economic growth, rapidly rising inflation (yet) or indeed a hostile Fed. Furthermore, we don’t see a weakening in company fundamentals in the main; in fact, we see just the opposite: the chart below displays consensus company earnings expectations for different years; as can be seen, earnings are expected to be strong in 2017.
Source: Factset, Waverton. Data to 23.06.17
Cycles vary in their length and intensity, and do not follow a pre-determined temporal pattern; and each phase can be shortened or elongated by a changing economic environment, the level of policy accommodation or indeed any other of a vast array of variables. Fisher[2] said that “instead of one cycle, there are many coexisting cycles, constantly aggravating or neutralising each other”, and that it is impossible for one person to keep track. As such, it is surely impossible to know where we are in “the” cycle.
As a portfolio manager one has to be pragmatic, remaining invested where the fundamentals dictate that you do so but ensuring appropriate diversification to protect against unknown unknowns and, more simply, the risk that we are wrong. Today, we see fundamental strength, decent global growth and potential upside catalysts to equity markets (US fiscal policy in early 2018 is still possible). We remain sanguine on the outlook for equities. Nervous Bulls, if you will.
By James Mee
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The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.
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[1] Leon G. “Lee” Cooperman is an American investor, hedge fund manager, and philanthropist. He is the chairman and CEO of Omega Advisors, a New York-based investment advisory firm managing over $3.5 billion
[2] Irving Fisher, The Debt Deflation Theory of Great Depressions, 1933
