It’s hard to stop a supertanker
08 October 2019
08 October 2019
Market conceptions of the economic world.
The world economy is like a 400,000 ton supertanker crossing the Indian Ocean. It speeds up and slows down and can change direction, but rarely does anything very quickly (apart from in huge financial crises like 1929 and 2008).
No wonder. The economic world is pretty stable most of the time. Companies make and sell stuff, people work hard, earn incomes and buy stuff, governments collect taxes and spend, goods are traded internationally if it’s cheaper. The supertanker moseys along.
But market perceptions of the economic world do change … sometimes dramatically. Late last year investors turned pessimistic about global growth and trade, and the S&P 500 index of large US companies lost 20% in the three months leading up to Christmas Eve. Then investors recovered their mojo, helped by falling interest rates, and the S&P 500 made up its losses by April 2019.
More recently, bond yields have fallen like a stone across the developed markets. US 10-year rates went from 2.5% in May to 1.5% at the end of August. German 10-year rates fell from zero to -0.7%. Investors now have to pay the German government for the privilege of lending it money.
Why? Some of this is due to the US Fed changing its noises on policy interest rates early this year, and cutting its key Fedfunds rate at the end of July. Falling short-term rates have dragged long rates down.
Equally importantly, investors have become fearful about slowing global growth and deflation this year. They’ve been buying bonds by the truckload.
Far from disastrous
Their fears are exaggerated. Okay, the world economy has been slowing: JPMorgan, the investment bank, expects 2.6% real growth in 2019, compared to 3.2% last year, with most of the major economies weakening. But 2.6% growth would be far from disastrous, and it looks as though global manufacturing – the most erratic part of the economy – will bounce late in the year.
Growth has slowed in the most important economy, the USA, but is still bumbling along at about 1.5% per year. And our proprietary Recession Risk Indicator says a US recession is unlikely in the next 6-12 months.
Meanwhile, US consumer inflation was 1.8% in August, and looks set to drift up. The labour market is tight and wages are rising steadily, while trade tensions with China are likely to raise consumer prices a little. This does not look like deflation to us.
From a long-term viewpoint, today’s ultra-low rates look like madness. Bonds are supposed to be a safe investment – but it’s hard to imagine circumstances in which holders of German bonds could make money, after inflation, over ten years.
We think the world’s investors are suffering another bout of deflationary psychosis, as they did in mid-2017. The madness should pass quickly … the global economic supertanker has slowed but is not grinding to a halt. ‘Investing’ in negative-yielding Swiss, German, Dutch and French bonds right now looks downright reckless.
We prefer to focus instead on assets with good macro stories that look fairly priced by historical standards. Two examples in our portfolios are US Healthcare stocks (political risks look exaggerated) and emerging market hard currency debt (underlying economies are in good shape).
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), the CII group, local institute or Society, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the CII group, local institutes, or Societies.