Growth boosting '˜Animal Spirits' finally returning?

6 January 2017

From a market perspective, 2017 has started on the same tune as 2016 ended: Stronger than expected economic data reports buoy risk asset markets higher and in some cases to new all-time highs.

Particularly the considerable improvement in business and consumer confidence in the US has in the new year sparked a discussion whether the low growth '˜ice-age' of the current economic cycle is finally coming to an end. Four positive developments are noted by the more optimistic commentators: The manufacturing and commodity price revival, a restart of corporate earnings growth, synchronized global economic stimulus as fiscal austerity is abandoned to appease discontent voters and a return of (mild) inflation expectations. On top of this there is the view that a President Trump will be - beyond all (Twitter) noise - pro-business, through lower taxes and less regulation.

This has led some to suggest that the recent confidence improvement may finally lead to a re-awakening of the economic '˜animal spirits' which have historically led to significant boosts in business investment and private consumption which are necessary for a return of healthier growth rates of 3-6%. The strong growth, so the further assumptions go, will soften the negative impact of rising cost of capital as more confident investors unwind the historic yield lows because they rotate out of bonds back into equities.

I am an optimist at heart and I can follow much of the argument, including the fact that this cycle has not witnessed any of the excesses that have historically heralded the nearing end of a cycle. However, in my opinion this view chooses to extrapolate economic parameters and ignore the potentially adverse political dimension. I have always argued that the main reason for the lacklustre economic development of this cycle is indeed the lack of general confidence, particularly of businesses who have become cash hoarders. 2016's pick-up in economic momentum with the 4 driving factors discussed above has undeniably led to a significant improvement in business confidence. But this recovery in sentiment remains brittle and can easily turn as the past years have shown.

For the moment business and capital markets appear to have given the benefit of the doubt to the new nationalist and simplistic tone in global politics, because if the promised rewind of globalisation was indeed executed, then the economic outlook would have to be far less optimistic, given the inevitable reduction in global trade and commerce. In principle I would agree that such a policy shift would be so detrimental to nations economic prospects, that more levelheadedness will prevail in the longer term. However, in the shorter term Donald Trump's aggressive megaphone diplomacy and politics and the UK's seemingly planless or even illusionary approach to an economically viable Brexit route, tell me that there is plenty of potential to undermine resurgent business confidence during 2017.

Therefore, and as already stated in the 2017 outlook published in December, this new year can take a number of directions, but given the experience of the last seven years it is probably unwise to expect either miracles in terms of a substantial economic breakout, or total disasters in terms of politics wilfully derailing recent economic progress. More realistic is a continuation of the slow normalisation process we have experienced since the end of the Global Financial Crisis (GFC). Sadly, this would also mean a continuation of what Wells Fargo's chief economist Jim Paulsen has so aptly named 'Bunny Markets', where lingering 'Armageddon Paranoia' leads to a regular recurrence of overshooting markets - in either direction.

On the back of the currently positive economic and market momentum, at Tatton we are expecting the earlier part of 2017 to continue to generate positive overall investment returns, but can foresee trading to become choppier as time progresses and old demons return. In such an environment we will confidently continue to apply our measured investment management approach to investors' portfolios, with which we managed to outmanoeuvre the various wrong turns 2016 offered and where once again able to allow our clients to achieve the investment returns that were achievable for their chosen level of investment risk.