Sharemarket will continue its run
This economic cycle is different but eventually a bust will follow a boom
It always astonishes me how the traditional cycles of economies and markets continue to repeat themselves. It shouldn’t surprise me
– it has happened so often – but that’s the nature of investing: people are surprised by booms and surprised by busts.
In each cycle there is always a different theme, political narrative or disruptive technology to contend with. And at some stage – generally close to the top of the boom – someone will always say, “But this time it’s different.” But, generally, the same forces of supply and demand, greed and fear always make things the same.
For Australia, a conversation about economic cycles must be measured against its performance of 28 years of positive economic growth with no recession. Interest rates also are at historic lows and are likely to remain there for the next 12 to 18 months, if current wages growth and employment data are to be believed. Both these things are aberrations in the traditional theory of economic cycles, yet the patterns of boom and bust seem constant.
Take house prices and the stockmarket right now. Melbourne and Sydney prices are falling and are expected to keep falling for the next 12 to 18 months. So where does an investor now put their money? Some of it is making its way into the stockmarket which, as I write, is at an 11-year high.
The general rule of the cycle is that at the top of the economic cycle interest rates are raised to curb economic demand, which cools down the stockmarket – initially. Money moves out of shares into property markets but eventually the higher interest rates should have an impact on shares as well, which is the foreteller of an economic slowdown.
This cycle is different because interest rates have already been at historic lows from the last downturn, during the GFC. Other factors have also curbed the supply of money, including regulatory measures by government to limit investment lending and to increase the reserves that banks must keep.
But the cycle is still working in the way it would have if interest rates had been raised to cool property market speculation. It also means money is being diverted to where – for now – there are better returns, namely the stockmarket. This makes some sense because many Australian companies are performing better than forecast, which is pushing their share prices even higher.
And this is where the cycle is not quite the same as normal. The money moving into shares seeking higher returns might normally move to cash as rates go higher. For the moment, with negligible wages growth and households with massive debt compared with their income, it is hard for the Reserve Bank to move rates anywhere.
And, as I have explained before, this makes it difficult when a global economic downturn eventually comes because, in the normal cycle, you would expect the Reserve Bank to cut interest rates. If it does not have a reason to raise rates now, it has less ammunition to support the economy in the event of a downturn. And bear in mind the Reserve Bank has repeatedly said it will not start to raise interest rates until it sees an improvement in wages growth.
This could mean the stockmarket’s run is longer than normal, as companies enjoy low interest rates, relatively slow wages growth and generally buoyant conditions. The only warning for these conditions might be a downturn in home construction, which in turn could impact retail sales (especially in home furnishings and electronics).
To combat the squeeze on household incomes, it is also clear that many families are changing their working arrangements. More women are entering the workforce and more seniors are staying in the workplace longer with the direct consequence that they are seeking to take the cost of living pressure off themselves. In other words, they are working longer and harder to alleviate the extra costs of electricity and health insurance and the confronting issue that they have insufficient money to genuinely retire.
Many of these trends are new but they should not distract from the obvious point. The economic cycle might be different but it rarely changes. And at this point of the cycle, judicious selling of stocks is a smart strategy to offset any future downturn.
The real problem, as always, is the timing of all this.