The global economy is doing great. Be afraid
COGNITIVE dissonance is in the air. This year’s mental split allows finance chiefs to believe that everything’s bullish, the world economy is finally in synchronised growth mode and markets are quite rightly on fire – while worrying that it is all just too good to last.
“Everybody’s making money, and the clouds on the horizon don’t look very threatening,” said Stephen Schwarzman, chairman and chief executive of private equity group Blackstone . “That’s enough to create a positive environment.”
Schwarzman is bullish on the economy, but like many others isn’t going all-in; the risks are just too great with asset prices already so high. Geopolitics and trade are the fears most often aired at the World Economic Forum this week, while an end to the easy money from central banks has a few concerned. Another danger comes from big investors buying into a rally they don’t really believe in, leaving them more tempted to race for the exit if there is any negative surprise.
“The consensus here is very, very upbeat,” said Michael Sabia, who runs US$300bil as CEO of Caisse de dépôt et placement du Québec. “This is a great period we’re in, but enjoy it while it lasts. I don’t think it will go may be inflation surprises so that increases in rates are faster than the market’s pricing, and that concerns me,” he said.
The twin questions are how far equities could rise before falling back, and when it might happen. Scott Minerd, chief investment officer at Guggenheim Partners, said he expects the Federal Reserve will increase rates four times this year instead of its forecast of three, and a recession is a danger next year as higher rates hit indebted corporate issuers.
But in the meantime, he says equity markets have “all the trappings of a mania” that could take the S&P 500 to 3600 this year, up 27% from 2839 on Thursday.
Minerd’s solution is to buy long-dated bonds to protect against the economy falling back, while buying cheap call options to capture a rise in share prices.
A simpler strategy can be followed by those who think things will probably be fine, but that there is a serious risk of Fed increases derailing the market. Buy banks and insurers, avoid technology and growth stocks that will be hurt by higher discount rates. Banks should do well in a growing economy and should benefit from rising interest rates and bond yields, at least until money gets so tight it hits corporate creditworthiness.
Nick Moakes, chief investment officer at British foundation Wellcome Trust, says he is “subtly altering the shape” of the trust’s £23bil portfolio after riding the market boom for the past nine years.
That means taking a little of the profit on the trust’s hefty technology-company holdings, and liking banks – in part because others will start buying them too to hedge against inflation risk.
“You would expect banks to become very well-owned,” he said.
The problem with this thesis, of course, is that it might already have happened. US bank stocks are up a quarter since the start of September, handily beating the market. Yet, for the past three years – broadly since investors started to believe that their capital problems were fixed – they have been an almost perfect leveraged bet on falling 10-year Treasury yields. Banks outperformed the wider stock market when bond yields rose, and underperformed when they fell.
Still, inflation and higher rates are minority concerns.
The predominant concern – aside from whether the next-door party might be better – is that no one is worried.
“The complacency is what’s really alarming,” said Martin Gilbert, co-CEO of Aberdeen Standard Asset Management. “Everyone’s worried about not being worried.”