Every year investors think about the challenges and opportunities in the coming 12 months. Important inputs in Australia's investment prospects are what is likely to be in store for the US and Chinese economies and for US equities.
Particular attention must be paid to whether the extreme gloom on the economic conditions in the US and China and on the US shar market has gone too far. In my opinion that is true. Although it is too early to be sure, this can be a false crisis again.
Usually our sharemarket follows the direction determined by US equities. An American recession is always followed by a bear market in equities around the world – even in Australia, even if, as in 2008-09, we have not followed the US in recession.
The recent build-up of expectations that the US will slide into an early recession reflects a wide range of questions, such as:
• After the arrest of Meng Wanzhou, the senior executive of the Chinese communications giant Huawei, is there a danger that the trade wars between the US and China will escalate again after the recent truce has expired or is being ignored?
• Would the US yield curve, which is now leveling off, soon turn around?
• Does the Fed overturn too much given the increases in the spot rate and the reversal of quantitative easing?
• The American share market is often considered too expensive; will prices fall further and cause a recession?
• Could the current revival of the American economy soon decline in old age?
• Will the high gearing of American companies cause a wave of failures and recessions?
I believe that market expectations for an early American recession are exaggerated. It is more likely that the US will grow slightly more than 2 percent in 2019 and that inflation will rise.
The growth of US jobs and consumer spending are good; and the budget is stimulating (too much?). The Fed has recently proposed a softer policy in monetary policy. (Would the Fed leave the US cash rate unchanged in 2019, or slightly lower, 2.5 percent?)
Also the previous concerns about the stretched valuations of US stocks have eased in recent months; the long-cherished one-year price-earnings ratio for the first fell from 18.8 times mid-year to 15.6 times the end of November, thanks to tax cuts and the fall in share prices
It is normal that some investors and commentators, especially those in or near the trading desks, suggest that the recession will follow the sudden fall in share prices. They emphasize the link that goes from shares to the economic outlook, more than that they acknowledge the link between the economy and the sharemarket.
In each country, particularly China in the first weeks of 2016, the predictions of an approaching recession became shrill when the monthly purchasing managers' index (PMI) was less than 50 points. We often hear that a PMI of less than 50 points to a contraction of the economy and that a PMI of more than 50 indicates expansion. But that is not correct. PMIs are a diffusion index based on surveys that ask purchasing managers whether things have improved, remained unchanged or deteriorated in the month. A declining score simply shows that companies find things relatively more difficult than a month earlier; a rising PMI simply means that companies feel better.
In November, when shares fell out of favor, Robert Buckland, global strategist at Citigroup (NYSE :), reminded investors that "every bear market (in stocks) starts with a dip but not every dip starts a bear market" .
Buckland maintains a checklist of 18 factors to help investors differentiate between a sale that needs to be bought and one that has to be sold. In November there were only four red flags: the valuations of US stocks were high (although the downturn was eased). On average, company balance sheets were somewhat spread out in share buybacks and debt-financed acquisitions, profit margins were close to cyclical highs and the US yield curve flattened.
With 14 flags that were "less worrisome", he recommended buying shares during the dive. "Our market targets suggest that global equities will end 16% higher next year," he said. "That suggests an attractive return for those brave enough to buy now, we are not perma bulls, but it seems too early to ask for time for this aging bull market."
But he concluded: "Trying to squeeze the latest revenues from a 10-year bull market (in shares) may not be a suitable strategy for less agile investors, and the late-cycle combination of lower returns and higher volatility may better to gradually evolve towards safer assets such as cash and government bonds.This accumulates the firepower to buy back in stock to the bottom of the next bear market.We think that will come, but only when we see more red flags . "
Market sentiment is also very negative in the outlook for the Chinese economy.
The trend growth in China certainly evolves over time, which is inevitable given the Chinese economy is much larger. There are also signs that the Chinese economy is slowing down cyclically.
History teaches that the Chinese are better at managing the economic cycle than Western strategists generally recognize. Helping high savings and international reserves. And there are no opposition parties or democratic elections to thwart necessary policy movements.
Don Stammer is an advisor to Altius Asset Management and Stanford Brown Financial Advisers.
