Poking the bears. Global growth rebounds in H2 2018
(This is an excerpt from our July 5 flagship report. Tomorrow we will publish another excerpt, addressing China's deleveraging)
When you have been wrong about the direction of markets as I have been over the course of the last few months, you have little margin for error regarding criticism. This is especially the case when I have reiterated, time and again over the last several months, a medium-term framework that has not changed despite financial assets telling me that it is currently wrong. The pushback I have been getting from clients is valid. Especially coming from those of you who have a shorter-term timeframe, because my conclusions that emerging market equities, especially in Asia, are incredibly attractive on a two to three-year view is simply not helpful. That said, despite some inherent biases that all of us battle with on a daily basis, I do try to be agnostic with my views and we do spend a lot of time looking at our prevailing themes and asking where we are wrong.
The honest answer is that I continue to come back to the same conclusions:
The Federal Reserve and the market are roughly in alignment regarding the trajectory of US rate hikes and as such, without a dramatic change in the outlook for US growth and inflation, interest rates across the curve will not rise or fall much from current levels. When the forward curve is pricing the articulated path of policy, then interest rate volatility should collapse, and US rates will cease to be a headwind for global risk assets.
For the fourth year running, pundits have overstated the threat of inflation in the US and more broadly the global economy.
Cash rates across the globe are uniformly below neutral and real rates remain negative in the vast majority of the developed world. I have not found a single example in the past 50 years of a developed market economy going into recession when cash rates were below neutral. Where is neutral? A wonderful question and this is something central banks around the world grapple with on a daily basis, but we can be confident that with European and Japanese rates below zero and a US economy that continues to bubble along, neutrality has not been reach in. Despite a higher oil price and a tighter Fed, financial conditions around the globe remain incredibly loose.
The outlook for global growth and profits remain intact and while sentiment could see multiples come in a bit from levels that aren’t expensive, world-wide profit growth as we stand today, is in good shape. The US remains on a tax cut induced sugar high. Europe has suffered a soft patch, but as I will elaborate later, extremely loose liquidity conditions should ensure that growth rebounds in the second half of the year. I believe European growth has bottomed and the outlook for European cyclicality is compelling.
There is very little evidence of the so called “deleveraging” of the Chinese economy. I believe the opposite. The PBOC has been adding liquidity for the past three months and as I will explain later, there are clear signs that credit remains robust and that activity should accelerate in H2 2018. Couple this with a trade weighted weakening of the RMB and the chances of a fiscal stimulus in the event that SMEs are hurt by President Trump’s push to curb Chinese imports, and we have a scenario of activity levels that will exceed the expectations of the consensus. In such a scenario, Chinese equities are the most attractive segment in our investment universe.
While tariffs and trade disputes are bad for sentiment, it is widely agreed that the economic impact of an increase in tariffs will not be huge and unlikely to alter the Fed from its anticipated tightening path. While sentiment can deteriorate for long periods of time, decreasing the multiple paid for global equities and credit, eventually the markets will adjust to a new growth and profit paradigm and value assets accordingly.
This isn’t about being contrarian. I am trying to be right
A natural response from those who are critical of this view is that I am doing this to be contrarian. I learnt a long time ago that selling subscriptions is not about being controversial; it is about being right. Time and again, I have returned to the views I have just espoused and while a spike in US inflation, a European recession, or a collapse in Chinese credit would force me to change, I currently believe this framework to be correct. Many of you disagree with this fundamental stance and the ultimate referee, market pricing, is on your side. That said, if the economic cycle evolves as I believe it will, the assets that I have promoted: long emerging market equities versus US equities (ex tech), owning long duration fixed income, short the USD against EM currencies, short the RMB versus the basket and long global technology will eventually be a compelling portfolio.
We have no control over the multiple that the markets deem to be fair for equities and credit around the globe. That is a function of sentiment. However, we can anticipate the profit outlook for the companies we study and the growth outlook for the economies we observe. Get this right and we are well on the way to making correct investment decisions. Currently, I think investors are far too bearish about the outlook for growth and profits and if I am right, sentiment will turn and there could be a scramble to reclaim exposure, especially in the emerging world.