Newell Palmer: Monthly Economic Notes – October 2018
The synchronised global expansion of 2017 has long receded. Growth has not only plateaued, but it has also become more uneven across regions this year. Increasing economic divergence and different performance of various asset classes are typical of an ageing expansion. The consensus is that we are currently in late-cycle of the current economic expansion. However, it does not necessarily lead to the conclusion that a recession is immediately imminent. In fact, a late-cycle expansion can last if excesses and major policy mistakes are avoided. A recession over a three- to five-year horizon is quite likely, but it is not currently visible in the immediate horizon.Monthly-Notes-October-2018.pdf
January’s burst of equity-market euphoria has given way to fear of a trade war, a more hawkish Fed and the return of volatility. The challenge of late-cycle investing is that equity valuations are stretched, there are worries about the economy overheating and the Fed is taking away the punchbowl. At the same time, economic growth and earnings are strong. The added complications are that the US federal government has enacted substantial fiscal stimulus at a time when the economy is at full employment, and President Trump is imposing trade sanctions that could escalate into a major trade war. However, the tit-for-tat tariffs triggered due to US steel and aluminium import tariffs are trivial in size. All the other tariffs are just proposals, contingent on the US and China being unsuccessful in reaching a negotiated solution. Hence, so far it has been a phoney trade war between the US and China.
Ten years since the global financial crisis, investors can find differing signals in the market. On the one hand, there are signs that economic growth is becoming less dependent on stimulus from central banks. On the other hand, valuations appear to be stretched for most asset classes. History suggests that average economic cycles are about 6 years long, but this year will mark the tenth year since the start of the recovery. We must keep in mind that recovery from a banking crisis normally take longer than other forms of financial crisis. Nevertheless, an economic downturn therefore might be expected in the not too distant future. Central banks are likely to become net sellers of bonds in 2019, as the exceptional post-crisis measures are phased out. Could that mark a turning point in the cycle? Or will some other event be a catalyst?