A dispassionate bull case

A dispassionate bull case

Moritz Sterzinger Weekly bulletin March 2019
Even a broken clock is right twice a day. Similarly, if you are one of those doomsday prophets claiming year after year that economic disaster is just around the corner, you will eventually be proved correct. Such “perma-bears” may have felt vindicated when the S&P 500 tanked by almost 20% from a high of 2,930 points in September to a low of 2,351 on Christmas Eve. I am still unsure as to what exactly triggered this correction, but the simple explanation that there were more sellers than buyers will do for me.
The global picture

In fairness to the bears, economic data hasn’t been stellar as of late, as outlined in last week’s bulletin: China’s growth is slowing (probably more than official numbers suggest), Italy is in recession and Germany has barely escaped one. Add to that deteriorating PMI figures and there is no arguing that growth dynamics look less impressive than they did a year ago. Other recession predictors, such as the inversion of the yield curve, have also sent ominous signals. Take the spread between 7- and 3-year USD swap rates, for example, which has been hovering just above 0% for the last year – very reminiscent of ’06 and ’99, which doesn’t exactly instil confidence.

Source: Bloomberg, JCRA

Central banks holding the gun

But while everyone was busy arguing the bear case, the S&P recovered to 2,806. I am as unsure of what triggered this reversal as I am of what caused the drawdown in the first place – but again, the simple explanation that there were more buyers than sellers will do for me. That said, the popular narrative has central bank policy holding the gun. The Fed’s tone has turned quite dovish and the ECB is expected to launch another bank lending programme, for instance by bringing back the previously employed TLTROs.

Both central banks have thus signalled that they are not too dogmatic about tightening monetary conditions, which should reduce the risk of policy errors. Moreover, rumours that the US and China will reach an agreement on trade this spring are making the rounds. The risk of a no-deal Brexit has diminished in recent days and, assuming it doesn’t make a comeback, this should be positive for economic growth both in the UK and the rest of Europe. Finally, governments have so far abstained from tightening their belts and looking back towards austerity, which could otherwise derail growth.

Not quite 2007

In arguing the bear case, commentators have been pointing out rising levels of household debt in the US, while ignoring the asset side of household balance sheets and the historically low cost of servicing that debt. Admittedly, corporate debt is worth keeping an eye on (which financial watchdogs seem to be doing) and could well lie at the epicentre of the next financial dislocation. Yet the overall picture looks markedly different from 2007, when banks and mortgage holders were hopelessly over-levered.

All told, global growth does look set to slow and one can’t rule out that some countries may tip into technical recessions. While this will no doubt be a drag on risk assets, claiming we are back in 2007 seems a stretch too far. I understand why one might feel a tad gloomy about the current state of affairs, but that caution may be precisely the reason why things won’t turn out to be too bad after all.

For more information, please contact Moritz Sterzinger, Director at JCRA, at moritz.sterzinger@jcrauk.com.

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