Economies are growing, stocks remain inexpensive, and liquidity is still plentiful: what’s not to like? The latter: in our view, stocks’ rise would be even more soundly based if central banks were playing a smaller role in the narrative. But these concerns are not enough to alter our tactical asset allocation: we stay overweight – if a little nervous – on developed stocks. We are also overweight cash – and we stay underweight selected fixed income assets and commodities.
Residents of the United States, please read this important information before proceeding
Please read this important information before proceeding.
Markets too optimistic on QE, too pessimistic on growth
We think investors are collectively placing too much faith in central banks, and not enough in the global economy. We doubt quantitative easing is playing a big role in driving growth, though it is of course flattering bond and other asset prices. But we also think received economic wisdom is still too gloomy, though this may not be visible in the weeks ahead as data for October reflect the US government shutdown.
Economic growth is the norm, and exceeds population growth. The setback caused by the financial crisis has been more than reversed
This subtlety may not matter much for our top-down view on stocks, though it does mean that we favour fewer “bond-like” sectors and more cyclicals, and continental Europe alongside the US as one of our preferred regions within developed markets. It also means that we think another taper caper could deliver some renewed short-term volatility in the months ahead. Our tactical view on bonds however would be very different – more positive – if we were less constructive on growth.
We are constructive on growth, QE scepticism notwithstanding, because a growing economy is the normal state of affairs (Figure 1) – something that has been forgotten in this financial-crisis-obsessed climate. In an underlying sense it is driven by real magnitudes such as the availability of labour and other resources, ongoing productivity growth and innovation. Many worries, if understandable, are overstated.
The developed world is not bankrupt – to think it could be is to forget that collective economic activity is not “funded” but pay-as-you-go in nature. Nor is it uncompetitive, or shackled by aging populations. We do not expect to run out of oil, metal, food or water; we see the euro as durable (if a bit expensive); we do not think the world is especially dangerous currently. The common belief that our children will be poorer than us is almost certainly mistaken.
Of course, these are all long-term points, and individually of little use in the tactical context. But cumulatively, they remind us how far received wisdom may have strayed from reality, and how much bad news may still implicitly be priced-in, even now.
Meanwhile, the latest results season is again suggesting that profitability remains respectable, and is being sustained without recourse to leverage. Across the developed bloc, we think plausible forward PE ratios still look unremarkable (page 19). We’d just be a little happier if investors were buying stocks for these reasons, rather than because they’ve been told not to fight the Fed.