Market Comment June 2019 - Is the glass half-empty or half-full
Market commentators talk a lot about “late-cycle” market conditions these days. They refer to the kind that prevail after a long expansion, when the economy is running at full throttle and assets are richly priced. This discussion quickly leads to gloom, doom and the nasty R word as in recession. This late-cycle debate is a battleground for two contradictory impulses. On the one hand, it recognizes that we are living the good times: the economy is strong, jobs are plentiful, and companies are humming with activity. Maybe the good times might last a little longer than usual. On the other hand, if it is late in the cycle, so the thinking goes, a recession cannot be far off. Headlines about anything that might bring that day forward, such as rising interest rates, a prolonged trade war, are selling well. These warring impulses set the stage for late-cycle markets. The general tendency is for prices of risky assets (shares and corporate bonds) to go up. Recurring fears of recession mean this rising trend will be punctuated by sometimes violent sell-offs. We have witnessed a few sharp sell-offs in the past two years with volatility and premiums going up strongly. Some have navigated the ups and downs by buying the dip which has proven to be a winning strategy. Yet a feature of late-cycle markets is that recession scares recur. Another may be brewing. This one has its origins in the growing rift between America and China over trade. Earlier this month the US raised its tariffs on Chinese imports. It has now hardened its position in the dispute by requiring US firms wishing to supply Huawei to seek licenses. Markets are choppier, although investors seem calm as most still expect a quick resolution. After decades of breaking down barriers and increasing global trade, it is hard for most to conceive a world in which each region develops its own separate technology standards. Can we still envisage the next decade in which China’s military operate on US software, and the US’s military operate on ‘made in China’ hardware? This latest step in the trade dispute started with a tweet from President Donald Trump. Another tweet might just end it. So why sell now? But the longer it goes on, the more harm it will do to business confidence across the world. Companies that have enjoyed the benefits of global supply chains and squeezing the best out of technological progress, may have to radically alter their business models. Or, it might just hopefully be a short-term disruption, that entails a weaker pace of earnings growth buffeted by rising costs and wages. If a deal is not struck at or before the G20 Summit in Japan on June 28th and 29th, we may see another sell-off. If trade peace breaks out, markets will jump higher. Even though, a fresh growth scare will emerge sooner or later as each of the world’s three biggest economies has a financial frailty: corporate leverage in America, a debt mountain in China and weak banks in Europe. Even so, it might still take a severe shock to kick off a global recession. If the economy keeps surviving and it may take a fresh dose of stimulus from China or the Fed to lift spirits, the conviction that the cycle can keep going may take hold. Market “capitulation” would in the present circumstances mean a “melt-up”, or a furious appreciation of prices. For now, it is hard to see past the trade skirmish and the G20 summit. Timing the next scare is not a challenge we want to partake. What is equally a challenge but where we feel a lot more confident is to identify companies that have a superior business model, consistent and growing sales, cash-flow and profits. These stocks will also gyrate under the day-to-day mood swings in the financial markets. Their future value is, however, likely to be much higher than today’s, no matter what. We like to think that the glass is half full.