Bull ... dust? Or bulldust?
Should investors turn and run? Ambrose Evans-Pritchard and Catherine Harris report.
New Zealand analysts have shrugged off warnings of a global financial setback from Citigroup’s star economist.
Willem Buiter, the bank’s chief economist and a leading theorist on monetary policy, said investors should cut their exposure to asset markets like the sharemarket before central banks shut off emergency stimulus.
‘‘There are clearly signs of late-cycle froth in financial markets, in everything from equities to corporate credit and real estate, especially in the US. There is the risk of an overdue correction.’’
He added: ‘‘We are reluctant to call an end to the bull market in risk assets just yet but a considerable degree of caution is now warranted. Downside risks are rising as the business cycle matures.’’
But New Zealand commentators are far from advising people to bail out, saying share prices were being justified by strong global growth.
‘‘Certainly valuations are getting a bit stretched in New Zealand, but globally perhaps not so much,’’ Craig Stent, head of equities with Harbour Asset Management, said.
As the boom continued, it would be harder to keep the party going, but generally company earnings and economic indicators were still healthy, he said.
Kevin Stirrat, head of investment strategy at Forsyth Barr, said the stimulus which central banks had been pumping into economies were finally working and expectations that inflation would rise this year were due to good reason – growth.
People were spooked by the fact that this cycle was not working the same way as previous ‘‘boom-bust’’ cycles because inflation had stayed low for so much longer, he said.
‘‘People have been saying the risks are extreme for the last five years and they just haven’t eventuated. So what I prefer to do is look at fundamentals and if you look at everything from labour market strength all round the world, consumer sentiment, business optimism, CEO surveys, PMIs, almost everywhere in the world are at record levels and forward earnings and revenues have been rising, justifying valuations.’’
Easing geo-political tensions on the Korean peninsula and more stimulus from US tax reform would also help.
‘‘So, are there risks? Yes, there are always risks, and the obvious one is rising interest rates if inflation does rear its head. But at the moment we’ve got very strong global growth synchronised with very low inflation. That’s a pretty powerful mix for equity markets in particular.’’
The key factor that has made markets nervous is the likelihood that central banks will this year slowly unwind the ‘‘quantitative easing’’ they imposed to ward off a cash crunch during 2008’s global financial crisis.
The US Federal Reserve is leading the charge, with plans to shrink its balance sheet at an accelerating pace.
‘‘Tighter monetary and financial conditions are a major risk. We think the direct effect of global tapering on the real economy is limited, but major asset market corrections could trigger or cause a global slowdown,’’ Buiter said.
But veteran analysts are starkly divided over where the world is in the global market cycle.
Renowned ‘‘value investor’’ Jeremy Grantham last week told GMO clients to jump in with both feet, predicting a Wall Street ‘‘melt-up’’ of more than 50 per cent in the near term – followed by a fullblooded crash later.
Nikolaos Panigirtzoglou from JP Morgan said excess global liquidity – which measures how far the ‘‘M2’’ money supply has risen beyond the needs of the real economy – has reached a record US$10 trillion and is still rising.
This creates a huge pool of money looking for a home in asset markets, and is doubly powerful at a time when corporate share buy-backs and a paucity of new share issuance have slashed net equity supply to near zero.
Buiter, a former UK rate-setter and professor at the London School of Economics, said the Trump Administration’s package of tax cuts and extra spending comes at exactly the wrong moment in the economic cycle and could make matters worse, leading to a blow-off boom that will force the Fed to slam on the brakes.
Citigroup estimates that net fiscal stimulus this year from the Trump tax cuts and infrastructure spending risks pushing the US fiscal deficit towards 5.5 per cent of GDP.
This is an exorbitant level at a time of full employment, when the economy is hitting capacity constraints.
Buiter said the policy is so egregious that it may ultimately cause global investors to question US solvency.
‘‘At some point people could start looking at the financial position and there could be fears of forced monetisation of the deficit,’’ he said.
Buiter said the greatest worry is that today’s benign ‘‘Goldilocks’’ conditions may give way to a ‘‘plateau phase’’ of slower growth in which corporate earnings stagnate and credit deteriorates.
Matt King, Citigroup’s credit strategist, said the wafer-thin return on corporate yields in both the US and Europe can no longer be justified. ‘‘Is it worth the risk you are running to get such a meagre return?’’ he asked.
For the past two years central banks have been soaking up the global supply of safe-haven bonds, pushing investors down the ladder into riskier forms of credit, leading to a compression of risk spreads.
Previous such shifts in bond purchases correlate closely with bouts of stress in credit and global equities. Most investors seem to think they are shrewd enough to ‘‘try to identify the catalyst for the regime change and then hope to be in front of everybody else rushing for the exits’’, he said. It is rarely so easy when the moment comes.
❚ Additional reporting: Daily Telegraph
"So, are there risks? Yes, there are always risks ... But at the moment we've got very strong global growth synchronised with very low inflation."
Kevin Stirrat of Forsyth Barr