It is said bull markets must climb a wall of worry, and the one we have been in since March 2009 seems a perfect test for this idea.
The summer threw worries aplenty at it. Geopolitical tension? Check. Puzzlingly low bond yields? Yep. Oil price scare? You got it. Inflation? Missing in action.
But for all this, stockmarkets pushed on to all-time highs and with the world economy now enjoying its best period of growth this decade, we see further upside.
This is not to ignore entirely any tail risks, or to overlook the advanced age of this business cycle, but in a period of synchronised above-trend growth and loose policy, risky assets probably have room to run.
Throughout 2017, growth data across the globe has generally surprised positively, with the momentum in the eurozone and Japan particularly strong. Although the level of growth remains quite modest by historical standards, its breadth is encouraging, not least as the shift in growth leadership away from the US toward the rest of the world has prompted a reversal in the US dollar.
At the start of the year, a further surge in the dollar was a profound concern to many investors. It threatened not only the nascent recovery in emerging market economies and commodity markets but also raised the spectre of a rapid and destructive spiral toward supply-side constraints and sharply tighter policy for the US economy.
Instead, however, the US appears to be sailing serenely into late cycle, with the combination of better global growth and muted inflation providing a fair wind.
Yet that same fair wind of subdued inflation, and the persistent easy policy it enables, is prompting disquiet on other shores. Bond market participants – typically a more circumspect bunch than stock investors – fear all might not be well in the economy.
To be fair, the bond market has a better track record of shining the spotlight on economic issues than the stockmarket, so if there is divergence between the two, we should listen to what bonds are saying, right? We would argue not.
The summer rally in US treasuries was driven primarily by falling inflation and ongoing global central bank buying, not by stalling economic activity. There are secular factors – notably auto-mation – that likely cap inflation by subduing labour costs, but many of the recent cyclical drags are transitory and global central bank buying of bonds is slowing, not stopping.
With these factors still defining the outlook for bond yields, it seems the stockmarket, not the bond market, has been more aligned with the economic trajectory.
Investors who agree with our positive view on growth should maintain a pro-risk tilt in asset allocation. That said, we remain mindful that, with the economic cycle maturing, liquidity and diversification are paramount.
Overzealous policy tightening still represents the greatest threat to a pro-risk stance but that risk seems to be receding. Indeed, with activity data positive but inflation subdued, the Federal Reserve’s rates and balance sheet normalisation plan seem to be subtly changing from “How much do we need to do?” to “How much can we get away with?”. And as the last few years have
shown us, modest growth, dovish language and easy finan-cial conditions are the holy trinity of prolonged bull markets.
John Bilton is head of global multi-asset strategy at JPMorgan Asset Management