The Bull Macro case under the Microscope

What could go right? In this wire, I’m taking a break from pessimism. I want to play devil’s advocate and explore what could go right with economic growth and investments: 

Up is usually the case 

In many facets of life, a more cautious approach is the responsible option. However, the natural tendency is for stock markets to rise more quickly than cash or bonds over the long term. Being too cautious in investing is a recipe for underperformance. Particularly for superannuation.

Yes, there are a lot of things that can go wrong with the stock market and the economy. But there is always something that could go wrong. There is never a period where there are no risks.

So, the hurdle needs to be higher for a negative outlook than for a positive one.

Trump wants to be re-elected

Trump’s best quality is that he is not ideologically wedded to many things. His worst qualities are the remaining things. 

This means Trump is capable of changing his mind when the facts change stock market falls. So if the US economy is genuinely looking at a downturn, then he will do whatever he can to support it. 

Trump genuinely wants to support the economy fiscally and has no acknowledgement fear of deficits. 

In our assessment, this is the right strategy as monetary policy has been exhausted. While tax cuts to the richest are one of the least effective ways to stimulate fiscally, Trump’s willingness to run deficits is relatively unique in the developed world. 

Presidential election years are usually strong in this regard.

Trade Wars

The trade war is negatively affecting both China and the US. While both countries have hardened positions, it is in the best interest of both leaders that a deal is reached. Both are facing domestic issues, and slow economic growth is not helping.

There have been signs Trump is willing to do a deal to solve the problem. His most recent back down shows he is feeling the pressure more than Xi.

Hong Kong

The 70th anniversary of the Chinese Communist Party celebrations is over. The celebration had the potential to create a flashpoint, and so the avoidance of that is positive.

Potentially, a US/China trade deal and growing exhaustion will lead the protests to die off.

Brexit

Y2K is an apt analogy. Unrecognised, Y2K had the potential to cause severe issues for computer systems around the world. However, the (relatively) early recognition and hype about the dangers meant Y2K ended up being a non-event. 

There is a reasonable argument to be made that Brexit is similar. If Britain left immediately after the referendum, there would have been chaos. But forty long months have passed. Companies and the government have had a lot of time to plan and prepare contingencies. 

There is likely to be some short term economic impact. But if the pound falls sharply, there is a reasonable argument that within three or four years, a new British economy will be growing faster than Europe. 

There will be fewer financial services jobs in London. I’m unconvinced that is a bad thing for the British economy. 

Kick the can

The motto of the political class ever since the crisis seems to be: “Why delay doing something until tomorrow when we might be able to wait until the day after.” 

Whatever the problem, if there is an option to delay short term pain and increase the long term pain, current politicians will take that option. 

For investment markets, it means more of the same. Goldilocks economic growth. Low enough to keep inflation down, not so high that central banks stop quantitative easing. Which means ever-lower interest rates. And financial assets keep increasing in value. That means ever-increasing inequality, which keeps wages low and profits high. 

Net effect for longer term investors and superannuation funds: the negatives aren’t enough to outweigh the natural tendency for markets to rise

The trouble with the investment bull case

The above scenario is not improbable. Most of it is a repeat of the last decade.

The problems with the above are:

• They are generally dependent on actions by politicians. And more importantly, actions that change the current trajectory.
• Central banks have exhausted most conventional means.
• Governments are generally not supportive of fiscal support.
• Some of the reactions probably need stock markets to fall first – i.e. if stock markets fall then central banks will act, or Trump will ease up on trade demands.
• The trade war is uncovering core issues in China’s economic and political models. These issues will not go away.
• Stock markets are a little expensive.
• Earnings growth is a bit weak.

Under the same conditions with stock markets 25% cheaper, I would be buying more stocks. Given current circumstances, we are limiting the exposure - particularly to Australian equities.

The problem is the confluence of uncertainty, with a reliance on political outcomes, and little margin of safety in stock market valuations.

The combination is enough to keep us wary. For the moment.