Investors have become used to six year-plus business cycles since the 1980s, but was the bout of stockmarket selling pressure last August and September presaging the end, or was it a mid-point correction on the way to the record books? If this cycle persists, investors are likely to be compensated for holding riskier assets.
The primary risk to the extended cycle scenario would be a negative growth shock, probably signalled by one of the major financial events that have preceded every downturn of the past 40 years. Did the dramatic sell-off in China’s onshore equity markets in 2015 constitute such an event?
This repricing spread through all growth-sensitive markets, from emerging markets and commodities to global equities and credit spreads.
The catalyst was concern over the slowing of China’s expansion. On the other hand, we have yet to see a major default, a run on a currency or a genuine market dislocation.
China is a front-and-centre risk, but concerns appear to be abating. Its third-quarter GDP release, though viewed sceptically by many, came in at a better-than-expected 6.9 per cent. Even after numerous cuts to interest rates and bank reserve requirements, China has extensive policy options at its disposal that can help soften its challenging transition to a more balanced economy.
It is wise to keep a close eye on real-time indicators, such as purchasing manager indices, to assess whether the country – and the global economy – is becoming more stable. This could help extend the current economic cycle and contribute to a more constructive backdrop for risk assets overall.
The key question in 2015 was whether the pullback in risk assets represented a pause, as in 2011, or anticipated a global recession. The latter prospect seems unlikely, given the resiliency of the US, budding growth in Europe and Japan and broad policy commitment to cushion economic shocks.
For these reasons, global stocks look preferable to global bonds. China’s road to a consumption-driven economy is likely to be long and bumpy, although a ‘hard landing’ looks unlikely. In developed markets, particularly in the eurozone, growth has been accelerating due to stimulus from the European Central Bank and improving business conditions.
For the near term, the US market may be hindered by reported earnings, which look to decline modestly year over year. However, 2016 S&P 500 earnings will likely be aided by more stability in the energy sector and the reduced impact of dollar strength on earnings comparisons.
Within bonds, credit looks more attractive than core developed market sovereign debt. With the exception of commodity-sensitive companies, corporate balance sheets are strong and maturities extended, while recent spread widening has created opportunities.
Within emerging country debt markets, hard currency sovereign debt is where we see attractive yield spreads for relatively strong credits, over local currency bonds which may be more sensitive to a rising US dollar.
Quantitative easing programmes are giving longevity to the current business cycle, but the side-effect has been to push up valuations in traditional assets and moderate their long-term expected returns.
The result is heightened sensitivity and microbursts of volatility in response to concerns over slowing growth on the one hand and tightening monetary policy on the other. These bursts of volatility can create attractive entry points for portfolios that want to remain positioned for an extended cycle.