New article from Tatton Investment Management: Goodbye 2019 - welcome 2020 and a new decade!

23 December 2019

Christmas, New Year and even a new decade are all approaching fast and so to close the year of Tatton Weeklies with this final 2019 edition, we will reflect on the changes of the last 12 months and indeed the past decade, and what that might tell us about likely developments over the coming year and decade.

The fourth quarter of 2019 has felt like a mirror-image of 4Q 2018. Liquidity was tight then, and is abundant now, particularly since the US central bankers restarted their purchases of US government bonds. Previous rounds of quantitative easing (QE) were aimed at bringing down longer term lending rates to stimulate the economy. But this time the Federal Reserve is buying assets in order to ease strains in New York’s short-term interbank lending markets. This may be an important point of principle for economists. However, it appears to make no difference to stock markets: they have rallied over the quarter as any fears of credit market stresses have receded further, even though the causes of such stress from a slowing economy have arguably increased.

The economy was strong 12 months ago but seemed to be weakening. Now, decidedly weak it looks to be strengthening for the coming quarters. Markets (especially the US equity markets) have behaved in the reverse way, as the chart below shows.



The start of 2019 saw a reversal of the market rout at the end of 2018, as it became clear the Fed was reversing course.

This time around, we do not think the Fed will reverse its liquidity injections meaningfully but there may be less headroom if further monetary stimulus was called for in face of a deteriorating environment. Meanwhile, expectations of an economic rebound could take some time. The release of Q4 2019 earnings during January will be watched closely for directional signals, but are likely to be underwhelming, showing no – or even negative – growth. That will stretch valuations in US markets further at a time when they are already trading at the very lofty heights of almost 19 times annual earnings. The last time we reached those levels was in January 2018, when they were accompanied by talk of ‘irrational exuberance’ and were corrected downwards considerably over the further course of 2018.

This will make markets nervous, but the notable difference between then and now is the most likely direction of travel of the global economy. Back then, it was feared to be coming off a synchronous high. Now, there is every expectation that it is improving from a synchronous low in growth rates. The evidence for this actually happening imminently is still feeble, with the strongest evidence of a turnaround once again – and somewhat surprisingly - coming from China, while the data flow from Europe, the US and Japan can at best be described as mixed.

Still, if there is a dip, many investors who have missed this quarter’s rally will be itching to buy at lower prices. The real danger is if there is a shock, and the most likely source remains US-China trade negotiations. These are on-going, and phase 1 was a very small win for the two sides. The rhetoric got a little more confrontational again this week, and phase 2 game playing is just starting. 2020 will be interesting.

2010/2020 - a decade back, one forward - Endings and Beginnings

Another day, another decade. As we come to the end of the only decade that is so far without a catchy nickname (how about ‘the Teenies’ to follow the Noughties’ of 2000-2009?), we thought it appropriate to look back at the themes and events that shaped the last 10 years – and dare to look forward to what might shape the next.

Looking Back

The 2010s started with diverging opinions on what was in store. In economic and financial terms, the 2000s ended about as badly as they could have. But after the horror years of 2008 and early 2009, initially it seemed as though the global financial crisis and ensuing great recession would prove to be just another short – even if very severe – recessionary blip after which things would return to the previous ‘normal’. By the start of the decade, asset values had mostly recovered, banks had recapitalised, the financial system no longer seemed dysfunctional, and the global economy had staged a remarkable growth recovery. Optimists (some on our own team) thought this rekindled stability would underly a return to strong global growth and put the nightmare behind us.

Pessimists disagreed, suggesting that the ghost of crises past would stay with us, ushering in a ‘lost decade’ of Japan-style stagnation. In a way, they were right. The extraordinary monetary stimulus from central banks managed to avoid a repeat of a disastrous 1930s-style depression, but over a decade since the crash, those ‘short-term’ crisis measures are still with us. Historically low interest rates, massive central bank asset purchase programs, and – crucially – sluggish economic growth have been the hallmarks of the last decade.

In the financial world, monetary policy has taken centre stage unlike ever before. Central bank guidance and policy meetings (such as the annual Jackson Hole conference) have become the centres of attention for global investors. Few could argue that support was needed to bolster the return of confidence in the financial system, but the trillions of dollars of liquidity provided by central banks have undoubtedly had a distorting effect on capital markets. Bond yields have sunk and remain below 0% for vast amounts of public debt, and elsewhere at least only around the rate of inflation. Volatility has been crushed and asset prices have become highly correlated, regardless of the quality and likely sustainability of their underlying profit streams.

Such long exposure to monetary intensive care – like any strong medication without sufficient rehabilitation measures – has had some uncomfortable side effects. If the rising tide lifts all boats, it does not matter which one you are on, and so high asset correlation prompted an exodus from active fund management into passive index-tracking funds. However, the lack of dispersion and the dropping away of active fund managers has meant that, when the market mood turns sour, there is no one to step in – leading to sharper price falls than we would have expected under similar circumstances in the past (as we saw at the end of 2018 and the beginning of 2016).

Sinking returns on ‘risk-free’ assets caused money that would otherwise have been seeking less risky sources of positive returns to pile into speculative investment opportunities –  creating cohorts of ‘reluctant investors’ who are much more prone to ‘crashing out’ again at the slightest hint of a market turn. The commodities bubble in 2014 was a prime example. ‘Reluctant investors’ were seeking investment returns in what they perceived as an asset class untainted by the aftermath of the financial crisis, but independently driven by the relentless catch-up in growth and natural resources demand of the world of emerging economies.

The unwinding effects of these false price signals to the resource industry became a key theme of the middle part of the decade as they caused the first mid-cycle slowdown in the demand for manufactured goods. Booming property prices, despite stagnant fundamentals (i.e. low wage growth), was another. Amidst investor resignation that low growth will be the norm we have seen high-growth technology stocks become the only game in town, leading to some extreme equity valuations as any form of meaningful growth becomes addictively attractive.

Financial distortion has also created economic distortion. Central bank policy has underpinned a broad-based and substantial recovery in asset prices – to the benefit of asset-holders. Meanwhile, wage growth has stagnated in the developed world, leading to a significant increase in actual as well as perceived wealth inequality. Those without prior capital stock – typically the young and/or low earners – have seen low or non-existent growth in living standards, while the older and better off have enjoyed some of the best returns in recent memory. This created populism amongst the not capital rich disenfranchised and subsequent geopolitical destabilisation in a way not seen since the 1930s. Accelerating climate change and loss of economic perspective motivated the younger generation and created fractions across western societies, with many worried about the longer-term consequences.

What caused that wage stagnation? .....

 

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