FYI | Jun 05 2018
By Peter Switzer, Switzer Super Report
5 global risks or 5 global opportunities?
Climbing the wall of worry with stocks means too many ‘experts’ are always troubling us with negatives that explain why we often miss opportunities. This has been a theme I’ve explored with you for as long as the Switzer Report has been going, which is about seven and half years!
Before that on Switzer Daily I canvassed the argument that, according to IBISWorld’s founder Phil Ruthven, in the first year after an Aussie stock market crash, the rebound can be between 30 to 80%!
Operating off the history that most stock markets pass their old record highs after a crash, I’ve kept arguing that every significant correction or dip was a buying opportunity. These positions were also supported by economic and company profit analyses that reinforced my historical perspective.
However, as we get more into this bull market, I am less bolshy than I was two years ago.
Of course, our market hasn’t passed our former record high of 6828.7 on the S&P/ASX 200 Index, but the Yanks on Wall Street have. Looking at Sir John Templeton’s rule of thumb with stock markets that says: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria,” the US market has to be in the euphoric stage, but we don’t know how long these stages last.
I’d like to think the local market will get out of the scepticism stage before we join a Wall Street crash in a few years’ time but I’m betting that we get into the optimism stage before it will be “all over red rover” for the local bulls.
For the sake of balance, I’m watchful for signs that might make me less optimistic about stocks, and AMP Capital’s senior economist, Diana Mousina, has offered up five concerns to keep an eye on.
Diana points out that while a strong global backdrop is currently positive for risk assets, she wants to pinpoint the risks to this rosy outlook.
“As we near the halfway mark for 2018, it’s good to see that the outlook for the global economy next year is positive,” she writes. “Though it doesn’t hurt to know which clouds on the horizon could weigh on growth and impact share markets.”
In looking at her risks, which I largely agree with, I thought it would be good to counter her with the opportunities ahead as well.
1. Europe, which has been a bright economic story, is looking messy and threatening. As Diana puts it:
“The Eurozone economy has enjoyed a strong cyclical rebound over the past year, despite some recent weakening in the data, with a clear convergence in growth across countries,” she says. “Structurally, the Euro area looks more stable, with an improvement in government debt, current account deficits and unemployment rates, and there seems to be increased positivity around the future of the Euro area, elevated with the election of pro-EU President Macron in France.”
However, things have changed. The Italian election now threatens Ital-exit, which I doubt will happen, but it is unsettling markets. Europe is starting to look dysfunctional, but I suspect they will muddle through, as they’re quite used to ‘dysfunctionality’!
If the EU can manage to avoid an Italian exit, then there would be a market rebound, just as we saw when Grexit was finally dealt with. That’s an opportunity.
2. US corporate debt has increased but given US economic growth, this debt increase has to be expected. But as Diana explains: “In the US, years of low interest rates have contributed to some lift in corporate debt, although not as high as the lead up to the Global Financial Crisis.”
The AMP Capital team thinks investors are probably too complacent around future risks in the US corporate sector, particularly as debt and leverage have been rising. However, a lot of that debt is funding the economic growth story of the USA, where the first quarter growth of 2.2% goes to 3.7% for the second quarter, if the latest consensus forecasts prove right.
So that debt increase is actually fuelling another opportunity.
3. US public debt is increasing (thanks to President Donald Trump’s ambitious fiscal plan), which is heading from a 3% of GDP level now, to 5% in a few years’ time, is a genuine worry.
However, even Diana admits that “stronger economic growth will provide some offset to the lift in spending through rising government revenues” but it will also help interest rates go higher.
The trade-off between public debt and growth is a critical part of this story. If the Trump experiment keeps US growth higher for longer, then the flirtation with bigger budget deficits could end up being more an opportunity than a threat.
Right now, Wall Street sees everything pro-business and pro-growth about Trump as a positive for stocks, and it seems to me that there’s probably a two-year opportunity window where the President’s excesses will sustain the US economy, corporate profit and the bull market.
The fact that inflation seems to be unable to defy gravity is a plus for those hoping interest rates don’t rise so fast that they close down this stock market party on Wall Street.
4. Lending standards and Australian home prices are two concerns that were off my radar screen until Diana’s colleague, Dr. Shane Oliver, pointed them out last week.
The Royal Commission and APRA are set to tighten loan approvals processes, which will make it harder for Aussies to get loans. This could have an economic slowdown effect, which could magnify the negatives for economic growth from falling house prices.
This has led some economists to ponder whether the next rate move will actually be down not up! At the same time, the consensus of number crunchers now telling us that the first rate hike will be in late 2019 is on the rise.
That has to be the second-best opportunity out of all this. The best scenario would be a faster growing economy and slightly higher interest rates, but I think a low interest rate environment, helping business conditions and business confidence readings remain at such historically elevated levels, is a pretty good second-best outcome.
If Wall Street can give us positive leads, then the local interest rate environment won’t be a threat to stocks. And if those low rates can also keep consumer confidence at the currently better levels, then this benign interest rate environment might end up creating a buying opportunity for stocks, provided company profits can tick higher.
5. Finally, higher commodity prices and inflation concerns have got the AMP Capital team a little nervous. “The global economic upswing is lifting inflation, particularly in the US where spare capacity is declining,” Diana explains. However, as she further points out: “So far, this lift in prices has been slow, which has allowed central banks to keep interest rates low. But, recent surges in prices of commodities such as oil and base metals, will lift prices in the near-term.”
That said, we don’t know how much inflation could be in the oil pipeline and I’d rather focus on the economic positivity around the outlook for oil prices, with $US100 a barrel often speculated. Meanwhile, analysts’ forecasts for the share prices of the likes of BHP and Rio, which have topped out around current levels, tells me that the global economic outlook and its impact on commodities remains broadly bullish.
In March this year, PIMCO (the biggest bond business in the world) headed its newsletter this way: “Commodities Outlook 2018: Still Bright.”
While not over-the-top bullish, the PIMCO brains trust concluded that “while we see potential for higher prices for most commodities, we believe oil, the largest component in nearly every commodity index, will remain range-bound.”
This belief that the conditions that have driven the share price of, say, BHP from the low of $14 to the $33 price of today, can be sustained has to be seen as another positive reason to be exposed to stocks, at least for this year, and I’d argue 2019.
By the way, I was surprised that Diana left out the Trump tariff tantrums and the potential for retaliation from the USA’s trading partners. That’s a wild card I find difficult to see an opportunity in, apart from risking a speculation that you should buy on the market slides, with each new Trump threat. But to do that is akin to punting, which I don’t recommend!
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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