Warnings of another recession appear exaggerated, with economics and corporate profits still going strong
We are entering a time of the year that has traditionally proved to be somewhat more volatile than other periods in the calendar. Whether this year follows the same pattern remains to be seen.
Industry commentators continue to speculate on when the next financial market shock might be or when the next economic downturn will occur, what might be the cause and what strategy might be the most appropriate.
What I know from a career that began in 1981 is that there will be periods of drawdown in the market (trees do not grow to the sky forever) and there will be periods when volatility increases. But what I have learned even more is that entry points and starting valuations matter most.
Simply put, buy at a relatively high price and your return expectations need to be lower than when you buy at a low price. And today’s starting valuations are not as attractive as they were.
Let’s dwell somewhat on the positive economic conditions for a moment, starting in the US. The Q2 real and nominal GDP figures increased at an annual rate of 4.2 per cent and the current dollar GDP increased to 7.6 per cent. Perhaps more importantly, Q2 US corporate profits have been very strong and expected returns are being revised up as a generalisation, rather than down, as usually happens at this point in the year.
Supporting the profits picture are the fiscal changes put through by President Trump, and boardroom confidence is in fine fettle. I cannot personally remember a recession occurring when corporate profits have been this good and the economy as robust as it is.
Unemployment is very low and inflation is under control, with a gradual tightening in US monetary policy consistent with robust economic health and a period of relative US dollar strength therefore not difficult to understand.
Elsewhere in the world, the economic picture is perhaps not as strong, but neither is it that concerning. Yes, there are many issues occupying the thoughts of money managers: the Brexit situation, European politics in general, trade wars and tariffs, the move to a tighter monetary regime by central banks and peripheral emerging market currency weakness, among others no doubt.
But, ultimately, it is economics and corporate profits that drive investor confidence, and these appear just fine for the time being. The probability that the very long bull market we have been in since 2009 lasts a year or two longer is quite high.
That does not mean markets cannot undergo a period of correction or indeed pause for breath, which from a number of perspectives would arguably be quite healthy.
The relative dominance of some of the growth names that have continued to drive markets, particularly in the US, will probably ease somewhat as huge profits have been seen in this area, while many other sectors and stocks within them do offer relative opportunity and decent risk reward characteristics, particularly if global economic momentum continues. If economic activity remains solid, some of the emerging markets should improve once again.
Above all, though, as I have said, the only real determinant of a good long-term investment, whatever the asset or asset class, is the price paid for the asset given the return expectation and the ability to buy low and sell high.
Here, we would have to conclude that most assets are not what we would describe as cheap and return expectations over the next 10 years will very likely be lower than they have been over the past 10 years, with a best guess being mid-single digit returns per annum on average. Investors need to be more discerning over what they buy and when they buy it, paying attention to genuine value assessment.
Gary Potter is co-head of multi-manager at BMO Global Asset Management