23 Sep 2019
Current Economic Backdrop
Chris Lioutas, PSK’s Chief Investment Officer
Bond and equity markets have begun to show signs of concern, and in some instances, signs of stress.
We have unorthodox politics (populism) along with pure political self-interest to blame for the recent state affairs. Equity markets have been more volatile and are at similar levels to those of 3 months ago, whilst bond yields fell (prices rose) sharply on rising recession fears before yields backed up (prices fell) more recently on concerns central banks (particularly the US) may not come to the rescue or may be ineffectual in "fixing" the current economic and political malaise.
As it pertains to the US Fed, they are stuck between a rock and hard place, in that their sole objectives are full employment and stable prices in the US economy, both of which have been achieved. Additionally, they are being baited and politicised by President Trump to lower rates drastically and provide more stimulus so he can further his trade war with China and so the equity market can keep humming along to enhance his chances of re-election. So the Fed technically doesn't need to provide more stimulus given their objectives have been achieved, but if they don't, President Trump will force their hand via his politics and make them look like an ineffective institution. No central banker wants a market crash or recession on their watch, stamped permanently on their CV.
Before we move on from the US economy, it's worth pointing out that the US consumer is yet again powering the economy ahead. Consumers are fully employed, with wages growth above 3% pa, household debt has been significantly reduced whilst house price growth has been strong, access to credit remains easy and borrowing rates have remained low, and we're now starting to see their savings rate rise for the first time in a long time. Absent the US consumer, the economy would be much weaker, so it's critically important for the economy and for President Trump's re-election chances that consumer confidence remains high. The trouble is consumer sentiment has been trending sideways for some time and has now begun to fall, with concerns regarding trade wars and a frothy US equity market, against a backdrop of weaker corporate earnings and potentially higher retail prices via the impacts of tariffs.
President Trump isn't the only one who's too heavily focused on getting re-elected. The same can be said for much of Europe, particularly the UK and Germany, with the latter in the midst of recession and the former likely to fall into recession if a no-deal Brexit takes place. The European central bank is out of monetary bullets, with their recent round of new stimulus (cash rate even more negative and new round of money printing / asset purchases) providing some support but not being as well received by the market as previous rounds of stimulus. Fiscal stimulus and transfers between the north and south of Europe are a must if the European Union is to survive. The question now is who has the political will to turn Europe around?
Asian and Emerging market economies look in good shape on a relative basis, absent the most recent problem child in Argentina. Most Asian and Emerging market countries have plenty of monetary and fiscal ammunition at hand, continue to enjoy the benefits of positive demographics / rising consumption / urbanisation / etc., and have undervalued currencies given some sharp falls on the back of increasing trade tensions. Whilst Asian and Emerging market economies won't be immune from a global slowdown or other significant market event, they will be better able to withstand these now than they ever have been.
Circling round to Australia, and it's difficult to be positive on the Australian economy whilst we have the trifecta of weak household consumption, anaemic business capital expenditure / investment, and a federal government hell-bent on achieving and maintaining a budget surplus so as to not use up any reasonable amount of political capital too early in their term in office. That all means the Reserve Bank of Australia continues to do all the heavy lifting, noting their increasingly public reluctance to provide any further stimulus. This reluctance, whilst sensible and rational, is futile as it currently stands with all signs pointing to an imminent and likely recession which is currently being staved off by higher resource prices. With the US Fed cutting rates, the Aussie dollar will remain stubbornly high unless commodity prices fall away significantly from here. Without a currency adjustment, and without the Coalition's willingness to use up some political capital early in their term, the RBA will have no choice but to lower rates further and contemplate money printing / asset purchases (QE).
In other matters, Brexit is more a sideshow than a major concern, whilst US / Iran relations are likely to worsen from here given recent events.
What does all mean for markets and your portfolio?
Whilst we've pointed out the reluctance of central banks to continue along the path of unorthodox policy, we also believe there's enough alignment, and too much reputational risk, for them not to continue to act as good global citizens and have greater regard for global matters outside of their local remits. As such, we expect central bank policy to continue to support both bond and equity markets, but importantly, to a lesser extent to than which they have in the past given the current starting point of policy.
That means the following remains important:
- don't try and time markets - it inevitably results in buying high and selling low
- don't follow the herd - the herd is momentum and momentum is expensive
- don't chase yield (income) or growth - chasing either at this point in the cycle means plenty of additional risk (both seen and unseen)
- diversification across and within asset classes and regions remains important - it may not work as well as we think in the very short term, but it will over the medium to longer term
- remain disciplined - benefit from the simple things such as portfolio rebalancing and compounding
- keep things simple - complexity means more unknowns and generally more cost
As always if you have any questions or concerns, do not hesitate to contact one of our advisers here at PSK.