Five more years for this cycle, redux

Even amid talks of recession and trade concerns, this cycle still seems to have some legs

Oct 10, 2019 | Krishna Memani

Coming into 2019, I had asserted that while growth was moderating, massive policy support from the world’s central banks ensured that the current cycle had at least another five years to go.

With the US Federal Reserve and other central banks delivering on the policy support front, that prediction was looking quite good for the past nine months. But investor sentiment seems to be wavering. Talk of a recession is now getting more airtime than it had at any previous point this year. With the manufacturing data continuing to disappoint and services slowing down, I fully understand the concern. Growth, at this point, is slower than what most of us had expected.

To be fair, my five-year view had not incorporated a more prolonged trade conflict. But that is what we have on our hands today. And the current situation will probably persist for a while.

Four more years – to be precise

The trade conflict notwithstanding, I continue to believe that the current cycle has a few more years to go. Both economic growth and profit growth are likely to be lower. The volatility of the markets may also increase, but the direction of growth is still positive, and so, we think, is the direction of the markets. This longest US cycle is unlikely to end anytime soon. For long-term investors, it is still too early to sell. So today, to be more precise, I should say four more years for this credit and economic cycle.

I say that while acknowledging that the weakness in manufacturing in the US, and for that matter everywhere, is self-evident. This was a sector that was suffering and slowing because of the withdrawal of policy support, and it got hit over the head with a two-by-four by the Trump trade conflict. The fact that it hadn’t slowed more was, in itself, a surprise. Given the easing of financial conditions and the impact of that on some sectors, manufacturing may stabilize, but the ongoing trade conflict will remain an issue.

The strength of the consumer economy may keep things going

The manufacturing slowdown is still only one small part of the story. The consumer segment of the economy continues to do well. In the US, and surprisingly in most large economies, low unemployment and improving incomes continue to support consumption. In fact, given relatively high savings rates, still decent income growth, and high household net worth, consumption will likely continue to be supported even if employment growth slows down.

The bottom line is that manufacturing is a drag and the trade conflict is not helping, but there is enough support in the consumer economy for a recession to be still very unlikely, in my view.

But that is not to say there aren’t issues that warrant concern. Trade, of course, is at the top of that list. But even on that front, let us be clear: as long as we stick with tariffs—which are a modest fiscal consolidation and which the markets expect to stay in place for some time—and do not exacerbate the situation by getting into non-tariff territory like fund flow controls or any type of investment restrictions, I believe, we will remain in the 1.5%-2% range for economic growth. In other words, the Trump administration would have to act irrationally and exacerbate a tenuous situation for me to change my view.

While the cycle continues, it is also fair to say that the growth outlook is likely to be more subdued until the uncertainty about what impact the trade issues will have on investments fades, and that is not likely to happen until we see the outcome of the US presidential elections.

The market impact of the current climate

So, what does all of this mean for the markets?

Given a more sober growth outlook and an unlikely accelerant to that outlook, the direction for the markets is still up. But the upside is more limited than it was coming into 2019. With low real growth, modest productivity growth, and low inflation, a profit growth rate in the mid-single digits is probably the best we can expect. As a result, there is likely a cap on the upside for the market. 

The case for credit is quite similar. Spreads are too tight to tighten much further. But given the low levels of government bond yields and the resumption of quantitative easing in most countries, spreads are unlikely to widen much.

The likelihood that cyclicals and value stocks do well in an environment of low growth and thus low yields, remains as remote as ever, the September turn notwithstanding. This is still a growth market, and if equities are going to do well, growth stocks, by definition, will have to do well. In that regard, the current market regime has not changed.

The continuation of the status quo probably applies to the US versus international stocks argument as well. In the current environment, with the trade clouds still dark and thick, it is difficult to see the US dollar weakening. And without that weakness, the global comparison story remains all about US equities. Yes, valuations are currently better outside the US, but much like the situation with value stocks in the US, the valuation gap is unlikely to close until trade issues fade, an outcome that is unlikely anytime soon.

The bottom line is that while the amplitude of the cycle has come down, the up-cycle continues without any significant change in the market regime.

In other words, FOUR MORE YEARS.

Krishna Memani serves as the Vice Chairman of Investments for Invesco.

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The opinions referenced above are those of Krishna Memani as of October 9, 2019.

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