Philip Saun­ders

Financial Mail - Investors Monthly - - Contents - PHILIP SAUN­DERS Philip Saun­ders is head of Multi-As­set, In­vestec As­set Man­age­ment.

As we ap­proach the sixth year of the cur­rent eco­nomic cy­cle there are con­stant re­minders of just how un­usual it has been by past com­par­i­son. The dra­matic fall in the oil price, re­newed con­flict in Ukraine, the po­lit­i­cal back­lash against aus­ter­ity in Europe, the Euro­pean Cen­tral Bank’s an­nounce­ment of quan­ti­ta­tive eas­ing, and lenders hav­ing to pay bor­row­ers to take their money in a num­ber of coun­tries have added to the sense that we live in ab­nor­mal times.

Growth has gen­er­ally re­mained stub­bornly sub-par de­spite highly stim­u­la­tive mon­e­tary and fis­cal con­di­tions. China’s spec­tac­u­lar growth rate has stut­tered and the com­mod­ity boom has turned to bust. In a more nor­mal cy­cle this would be the time when in­vestors would be wor­ry­ing about di­min­ish­ing ca­pac­ity, over­heat­ing and mon­e­tary tight­en­ing, the kind of con­di­tions that nor­mally bring the party to an end. At such times in­vestor sen­ti­ment has typ­i­cally been eu­phoric, whereas, de­spite strong per­for­mances of de­vel­oped mar­ket eq­ui­ties and bonds in lo­cal cur­rency terms, this time sen­ti­ment has re­mained brittle. As the Doors’ Jim Mor­ri­son once sang, th­ese are in­deed “Strange Days”.

So what is 2015 likely to hold and where are we in cycli­cal terms? The world econ­omy labours in the twin shad­ows of the global fi­nan­cial cri­sis and the nat­u­ral end of the long Chi­nese boom. The for­mer weighs heav­ily on the de­vel­oped world, whereas the lat­ter con­tin­ues to de­press the emerg­ing world. Caught in such cross cur­rents, in­di­vid­ual coun­try cy­cles are highly desyn­chro­nised, ev­i­denced in weak com­mod­ity prices and per­sis­tent de­fla­tion­ary pres­sures. Debt lev­els that many thought would have to decline — the “new nor­mal” — have done the op­po­site. Delever­ag­ing is miss­ing in ac­tion. How­ever, there is a strong case against ex­ces­sive fu­ture pes­simism. The ges­ta­tion pe­riod has been a long one but the key US econ­omy ap­pears to be on track. Con­sumers have re­trenched, the banks have been re­cap­i­talised and are now lend­ing nor­mally, and con­sumer sen­ti­ment, hav­ing shown grad­ual im­prove­ment, has rock­eted over the last six months.

Lower oil prices, if sus­tained as we think they will be, are like heavy rain­fall af­ter a drought and will pro­vide a sub­stan­tial boost to US con­sumers and oth­ers. The dollar’s dra­matic rise against all world cur­ren­cies since July 2014 ap­pears to have been a barom­e­ter of the change of gear in the US econ­omy, sug­gest­ing that it was al­ready emerg­ing from the more gen­eral slough of weak growth be­fore the ef­fect of weak oil prices was felt. Cer­tainly the rapid con­trac­tion of the for­merly buoy­ant en­ergy sec­tor in the US and the dis­rup­tions at its west coast ports may ob­scure the trend in the near term, but in our view, the ex­pan­sion is suf­fi­ciently broad-based to stay the course. In time this will help pro­vide more gen­eral global eco­nomic trac­tion, re­sult­ing in growth fi­nally ex­ceed­ing con­sen­sus ex­pec­ta­tions. In the cases of Ja­pan and the eu­ro­zone this could hap­pen sooner than eco­nomic fore­cast­ers sus­pect in re­sponse to the lagged im­pact of ma­te­rial cur­rency weak­ness and other stim­u­la­tory mea­sures.

Such a back­drop re­mains con­struc­tive for mar­kets. True, in­creas­ingly diver­gent mon­e­tary pol­icy tra­jec­to­ries are likely to re­sult in higher volatil­ity, but a steady and im­prov­ing growth pic­ture should use­fully un­der­pin cor­po­rate earn­ings growth, while low in­fla­tion and con­tin­ued loose mon­e­tary poli­cies out of the US should keep real short- and longterm in­ter­est rates low. Against such a back­ground de­vel­oped mar­ket eq­uity val­u­a­tions are rea­son­able and eq­ui­ties should de­liver pos­i­tive re­turns. De­vel­oped mar­ket bonds may even ex­tend their secular bull mar­ket to an in­cred­i­ble 34 years. Euro­pean, US and Ja­panese prop­erty as­sets should also be well sup­ported.

Emerg­ing mar­kets may ex­pe­ri­ence a bumpier ride. Eq­uity val­u­a­tions are rel­a­tively cheap, at least in ag­gre­gate, but op­er­at­ing per­for­mance re­mains poor and we sus­pect that cur­ren­cies may need to ad­just fur­ther. Af­ter the end of a long cy­cle it would be un­sur­pris­ing if there weren’t a few high pro­file ca­su­al­ties be­fore it is safe to de­clare the all clear. Typ­i­cally, new emerg­ing mar­ket cy­cles are in­cu­bated in pe­ri­ods of re­form and In­dia may point the way here.

To con­clude, it is too early to call the end of the cur­rent cy­cle. It is likely to be an un­usu­ally long one with sev­eral more years to run. Jim Mor­ri­son also once pro­claimed that “this is The End”, but this is a sen­ti­ment we do not agree with.

Lower oil prices … are like heavy rain­fall af­ter a drought

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