End of globally synchronised growth upswing
26 May 2017
At the end of weeks like this, I tend to struggle with the prospect of writing about the economy and global investment opportunities. However, it is not the purpose of these pages to pass comment on what may have made our world as divisive and lacking in moral restraint as the past week’s event so painfully demonstrated again. My heart and thoughts go out to all affected, and I sincerely hope that the community cohesion Manchester so powerfully demonstrated this past week will become a more effective antidote to the divisive aims of the terrorists than all other counter-terrorist measures.
Back to the economy and markets.
Data flow around the globe continues to present a mixed picture. There are clear signs that Chinese economic growth is slowing in response to tightening credit availability, as the authorities clamp down on China’s (still) sprawling shadow banking sector. While China in Q1 was still growing at one of its fastest rates in some years, growth in the UK and the US had already meaningfully slowed.
The Eurozone, on the other hand, has finally entered a period of better growth rates, after having been stuck for so long in the slow growth rut. Japan has shown similar signs of accelerating growth, and, given the savings surpluses of the Japanese population and their considerable domestic demand potential, the country finds itself in a similar position to Europe.
The fly in the ointment is that, compared to the US, both regions are more deeply integrated in global trade. Should China slow as expected and the US not re-accelerate, then their falling demand for Japan’s and Europe’s exports would constitute a considerable headwind to the current positive growth momentum.
Unfortunately, this means that the highly encouraging synchronised global growth scenario we observed during the first quarter of the year has, most probably, already ended. This is not to say that this slowdown in growth will lead to a contraction of growth and recession. What it does mean, however, is that the overall growth prospects for 2017 have been reduced to just a slight improvement over 2016.
This matters, because capital markets value investable assets on a forward looking perspective, rather than looking back. As I commented last week, on this basis, equity market valuations – particularly in the US and the UK – look frothy and thus vulnerable to any indications worse than simply moderating of previously overly optimistic expectations.
This week, Tatton’s investment committee therefore decided to take some profits and lower the overall exposure to global stock markets across all portfolio strategies by approximately 5%. On the basis that markets remain relatively calm and are trading at close or at their all-time highs, we are rebalancing portfolios gradually, which will allow us to implement various fund selection upgrades at the same time.
Even though this is the first time since 2013 that we have explicitly reduced our stock market allocations below the standard allocations, our relatively measured move (of only half of the maximum amount our management mandate permits) indicates that, while we would expect temporary market setback, we are not expecting the imminent end of this investment cycle.
Our central case for the coming 12 months remains one of resilient global growth and gradual monetary policy normalisation. Over the coming 3-6 months, however, we expect stock markets to struggle to reach much higher valuation levels than they have already achieved, but with a considerable chance of a short sharp selloff, not dissimilar to January last year. This risk reduction move should therefore lower portfolios’ potential for short term value fluctuations (volatility reduction) without costing much - if any - loss of upside. Or, it could provide us with the opportunity to buy back the equity positions we are now selling, at lower prices.
In order for our view to change over the coming months, we would need to see a stronger resurgence of growth in the US in Q2 than already anticipated (and therefore priced in) and/ or a much lower reduction in China’s rate of growth than current credit tightening effects and falling commodity demand would suggest. We will therefore be monitoring all critical parameters of economic activity across the major economies even more closely, to detect early whether our short term view is too optimistic or too pessimistic, relative to our portfolio positioning.