End of the Cycle

global economy in danger zone?

I mentioned yesterday about the slew of strong economic data coming out of the US last week. Overnight, Australia responded with its own news bombshell.

That is, Billy Slater is out of the opening State of Origin match on Wednesday night! As a long suffering New South Welshman, I think this is a desperate ploy by Queensland to wrest the psychological advantage off NSW and firmly claim the underdog tag. We all know that Queensland does best (at least when they don’t have four or five of the world’s best players EVER in the team) when they have the underdog status.

But c’mon. NSW has 11 blokes in the team that have never played origin before. The NSW press may have the speedsters in the team running around QLD’s flanks like kids in under 8’s, but if NSW believe they’re favourites then they’re done. QLD will get them in the last five minutes…again.

As the saying (in NSW) goes, 14 times bitten…

But I digress. Actually, I didn’t even make a point to digress from. I got waylaid from the start. I clearly have a bit of origin fever.

So let’s get to it…the never ending quest to work out where economies and markets are heading.

As I pointed out yesterday, the US economy is as strong as an ox. Trump’s tax cuts are starting to have an effect. They’re working through the economy via higher consumer spending and employment growth. But with monetary policy still easy, and fiscal policy as loose as a nut on an Aeroflot jet engine, it should not be all that surprising that the US economy is humming along.

The job of an investor though is to not merely consider what has happened in the economy. When the news hits, it’s in the price. Today’s news, whether good or bad, is old news. A good investor tries to see where things are going. Not where they’ve been.

 

 

Usually, it’s a safe bet to assume what has happened today will continue tomorrow. Now, I realise the potential folly of that statement. What I mean by that is that economies and markets move in cycles. These cycles are slow moving, and while volatility occurs within cycles, they generally continue for years.

The trick is to try and work out when the cycle may have ended. That is, when the economic and earnings expansion has reached its peak.

I’m working on the assumption that the US economy will peak in 2018, and that the market may well have peaked in January 2018.

What evidence do I have for that?

Well, monetary policy looks set to tighten throughout the rest of the year, starting with the Fed’s next meeting on 13 June. And there are a few more to come after that. According to Reuters:

The Fed is about three rate hikes away from reaching a “neutral” level, where interest rates are neither adding to or taking away from economic growth, San Francisco Fed President John Williams told Reuters in his last interview before the Fed’s June policy-setting meeting, when the U.S. central bank is expected to raise its target range for the short-term benchmark interest rate to 1.75 percent to 2 percent. 

Neutral, Williams said, is probably around 2.5 percent, meaning that rates above that level would likely act to slow economic growth.’

Probably around 2.5 percent’ doesn’t sound too confident. The truth is, the Fed has no idea where the ‘neutral’ interest rate setting is. They never have, and never will.

There is every chance that by the end of the year (with three more hikes under their belt), the Fed may be running a tight monetary policy.

In addition, fiscal policy is stretched and unlikely to provide more stimulus into 2019.

When you combine this with the fact the market rallied sharply at the start of the year, and has struggled ever since despite good news and good earnings, probability suggests the upward advance is done for now.

And then there’s this, from the Wall Street Journal:

Hunting for cheap stocks has been out of favor for so long that some self-proclaimed “value” investors are embracing a broader mandate, a potentially costly move in the later stages of an economic cycle.

Many such buyers have drifted away from the hallmark of value investing championed by the likes of Benjamin Graham and Warren Buffett: actively picking stocks the market has overlooked. Those legendary investors assessed what they called a company’s intrinsic value and compared it with metrics such as its cash flow and price-to-book ratio, a measure of net worth.

Value stocks—traditionally shares of consumer-staples companies, basic materials firms and big manufacturers, among others—have been stuck in a rut for most of the nine-year rally in U.S. stocks. The Russell index of 1,000 of the biggest value stocks in the market has fallen 2.1% in 2018, the fifth straight year—and the 10th of the past 11 years—that the index has lagged behind its growth counterpart, which is up 6.9%.

Everything goes in cycles. It’s been a long cycle of ‘growth’ outperforming ‘value’. But you have to ask whether this is another reason why the market’s strong run may be coming to an end.

 

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan

Greg Canavan

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

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