Current lack of drama should not be a source of unease
AFTER a busy week for economic data, we are again left arguing that the prospects for the world economy look well founded. Business confidence remains at encouraging levels around the world, while activity is increasingly broad based across the global private sector. While this increasingly undeniable economic health has helped to slow the predictions of imminent investor doom to a trickle, there are still signs that nerves and doubt remain.
Many continue to mistakenly see in the 'Great Financial Crisis' the template for how all business cycles end. Remembering that the last recession sits at the more extreme end of the seizures experienced by the world economy in the last 100 years, as well as the fact that such seizures have actually been becoming less frequent and less violent over the last few decades, provides important investing context. But for the moment, we remain content to say that the indicators that we look at do not suggest the next recession is imminent.
The valuation debate has not moved on this year. Earnings have grown sufficiently so far to leave price to earnings ratios, dividend yields and other metrics more or less where they started the year in spite of surging stock prices. Remembering that valuation is simply not a very important input into tactical allocation is important here. More broadly we are still comfortable arguing that, based on the level of dividend and bond yields, the excess return available from stocks still suggests a dominant influence for the asset class in portfolios.
We do see some scope for equities to de-rate mildly as interest rate expectations firm up through the rest of the year. However, the profits growth derived from that healthy global backdrop will provide sufficient offset to leave total returns comfortably in positive territory.
Many also will point to rising geopolitical heat in various troubled spots of the world as a reason to hide (North Korea, Trump etc). Humility is appropriate here – if the major protagonists in these various hot spots do not know what they are going to do next, we should be wary of trying to second guess them.
This is where the power of diversification across geographies and asset classes comes in. Tactical allocation can play a defensive role of course, but right now we do not see enough cause in any of these to bet against a global economic juggernaut that continues to gain a little momentum.
That little dramatic is happening at the moment should not be a source of unease. The business cycle is not a horror movie, where silence is the inevitable precursor to some gory climax. Economic growth, founded as it is on the interaction of the learning curve with new technology, is a little more prosaic and less fragile than the caricature.
In such a context, dramatic predictions should mostly be seen as a desperate grab for investor immortality, more often than not based on misunderstandings about the nature of the business cycle, the role of valuations in returns or poorly contextualized geopolitical threat assessments.
A portfolio diversified across geographies and asset classes, but still leaning towards equities remains the most appropriate tool to bring to bear… and some earplugs perhaps.
:: Jonathan Sloan (email@example.com) is a private banker at Barclays Wealth & Investment Management