4th January 2016
Canada Life Investments head of UK equities Craig Rippe takes a look at the potential challenges pitfalls and opportunities which lie ahead for investors…
Bears argue that equities – and bonds too for that matter – are expensive, that imminent rate rises will finish off any remaining strength, and that the US market cycle is getting very mature.
They point to unemployment levels in both US and UK sitting at near-trough levels, auto sales back at peak levels, and consumer discretionary stocks that have been blisteringly strong for seven years. Based on these factors alone, is it time to batten down the hatches while the herd is still buying?
Calling the cycle is fraught with problems, but here are a few thoughts:
Cycles don’t die of old age, they die of excess. A typical recession begins with an overstocked supply chain. A confidence blip causes a dip in consumption. Order cancellations then ratchet through the supply chain causing chaos at the manufacturing end and, if big enough, trigger a recession.
Such is a ‘normal’ correction. These are not normal times, though. The current cycle has seen unprecedented monetary loosening, a protractedly weak recovery, and a huge and growing debt pile. Governments are paralysed by the need to stimulate growth whilst also needing to raise taxes to repay debt.
Ashtead, a US-exposed construction equipment outsourcer, is a great canary in the coal-mine. When we last saw the CEO this summer, he observed, “UK investors ask us if the cycle is over yet; US investors ask us if it has started yet”. We largely concur with the sentiment – this cycle is so weak as to have not even clearly begun yet in at least some industries.
What we’ve also not seen this cycle is corporate confidence. Finance directors have not invested in new equipment, preferring instead to hire cheap labour and return spare cash to shareholders. This is borne out by other indicators. In the US for example, construction remains near a 30 year low share of GDP.
The four initial rate rises since 1977 do not make a strong case for any particularly significant market move.
Moreover this is probably the most widely flagged interest rate rise in all of history. But I believe rates cannot move far in any case. Those debt piles around the world need repayment and are swallowing free cash flow, therefore constraining growth, inflation and interest rates.
The market concurs, with prices implying next-twelve-month rate rises in the US of only 0.7%.
On the negative tack, profit margins are high and look as though they have already peaked. The popular US leading indicator, the ISM New Orders Index, has already fallen to contractionary levels.
There are always risks, and these are not normal times. Despite concerns, we are positioned for more of the same – a continuing protracted, weak cycle. Strong, stock-specific investing remains the cornerstone of our portfolio.