As the Doors’s Jim Morrison once sang, these are indeed “strange days.” Growth has generally remained stubbornly subpar in the face of highly unorthodox and stimulative monetary and fiscal conditions. In total, 26 countries cut interest rates during the first three months of the year, despite the current economic cycle being six years old. Lenders even have to pay borrowers to take their money in a number of countries.
So what is the rest of 2015 likely to hold, and where are we in cyclical terms? The world economy continues to struggle in the ongoing recovery from the 2008–’09 financial crisis and the natural end of the long Chinese boom. The former weighs heavily on the developed world, whereas the latter continues to depress the emerging world. Caught in such crosscurrents, individual country cycles have become highly desynchronized, evidenced in weak commodity prices and persistent deflationary pressures. Deleveraging has been missing in action.
We shouldn’t be excessively pessimistic about the future, however. The gestation period has been a long one, but the key U.S. economy appears to be back on track. Consumers have retrenched; the banks have been recapitalized and are now lending normally; and consumer sentiment, having shown gradual improvement, has skyrocketed over the past six months. Lower oil prices, if sustained, as we at Investec Asset Management think they will be, are like heavy rainfall after a drought and will provide a substantial boost to consumers in the U.S. and elsewhere.
The dramatic rise in the U.S. dollar that has occurred against all world currencies since July 2014 is an indicator that the world’s largest economy was already on a growth trajectory before the slump in oil prices became pronounced. The rapid contraction of the formerly buoyant energy sector in the U.S. and the labor strikes at West Coast ports may obscure the trend in the near term. In our view, though, economic expansion is now broad-based enough to stay the course. This will help provide more general global economic traction, resulting in growth finally exceeding, rather than disappointing, consensus expectations. In the cases of Japan and the euro zone, this could happen sooner than economic forecasters suspect because of the lagging impact of material currency weakness and other stimulatory measures.
Such a backdrop remains constructive for markets. True, increasingly divergent monetary policy trajectories are likely to result in higher volatility. A steady expansion stands to underpin corporate earnings growth, though. Low inflation and continued loose monetary policies outside the U.S. should keep real short- and long-term interest rates low. In light of these economic conditions, equity valuations in developed markets are reasonable and should deliver positive returns. Developed-markets bonds may even extend their secular bull market to an incredible 34 years. European, U.S. and Japanese property assets should also be well supported.
Emerging markets may experience a bumpier ride, though. Equity valuations are relatively cheap, at least in aggregate, but operating performance remains poor, and we suspect that currencies may need to adjust further. After the end of a long cycle, it would be surprising if there weren’t a few high-profile casualties before it is safe to declare all is clear. Typically, new emerging-markets cycles are incubated in periods of reform. India may be pointing the way in this regard.
Generally speaking, though, the current economic cycle is likely to be an unusually long one, with several more years to run. Jim Morrison also once proclaimed, “This is the end.” That is a sentiment with which we do not agree.
Philip Saunders is co-head of the multiasset team at Investec Asset Management in London.
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