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10/9/2018 — General
Profit the bottom line for bull market
By Dene Mackenzie

Globally, the economic expansion remains intact, led by the United States and Forsyth Barr broker Damian Foster says despite recent market volatility, manufacturing data confirms a moderating but still growing global economy.

Transportation and logistics activity were also consistent with global trade holding up, despite negativity around tariffs and trade negotiations.

The second quarter reporting season in the US delivered earnings at all-times highs and profit margins continued to expand but with inflation remaining subdued, central banks would keep interest rates at accommodating levels.

As global growth expanded at a moderate pace, and inflationary expectations remained anchored, the current economic cycle could continue well into next year and possibly beyond. However, uncertainty and risks remained particularly with US-China relationship, Foster said.

“The growth outlook remains more compelling and we maintain our overweight exposure to global equities.”

The domestic markets of NZ and Australia had challenging headwinds as business sentiment plunged while, at the same time, equity valuations remained at cyclical highs. He said NZ real interest rates remained some of the highest in the developed world. Softening business intentions made the country’s higher-yielding securities attractive to domestic and global investors.

“It’s worth repeating the old market adage bull markets don’t die of old age. They are usually killed by recessions.”

Economic expansion remained on track and given what was known about the impact of tax cuts and deregulation in the US, further tightening of labour markets around the world, an absence of broad-based inflation and continuing stimulatory monetary policies from most central banks, there was a good chance the current economic cycle would continue.

He said bull markets were driven by earnings and earnings tended to be pro-cyclical. Some key points emerging from the US reporting season included revenue at all-time highs, earnings at all-time highs, profit margins at all-time highs and widespread sector strength.

The market “bears”, or pessimists, had worried about the flattening yield curve being an imminent sign a recession was approaching.

“Peak earnings have been as common refrain, as has global debt and the age of the bull market. However, the current economic fundamentals remain supportive of equities pushing higher as economic expansion remains intact.”

Leading indicators in the US – the yield curve being the exception – continued to record fresh new highs throughout July, Mr Foster said. US gross domestic product growth was more than 4% annually.

Signs of progress in the trade were also encouraging. US President Donald Trump called an end to the trade war with Europe. An agreement had been signed with Mexico and talks had resumed with China.

Rather than escalating, Trump’s salvos might be starting to work in reducing overall global protectionism, something positive for global trade, Foster said.

In the US, the Transport Index had outperformed the Dow Jones index in the past year, 24.3% versus 17.9%. Much of the credit went to the railroads. Rail car loadings, excluding coal, were at record highs.

Excess shipping capacity had pushed down sea-borne freight rates and a global trade war would make the situation worse.

Looking at some of the global risks, Foster said they centred on global liquidity and currency wars. Since the start of the year, many central banks had joined the Federal Reserve in lifting official cash rates. Most of those had been emerging market policy makers as they tried to stem their own currency weakness or manage inflationary pressures from falling currencies.

The combination of quantitative tightening in the US, the repatriation of the US dollar following tax reform and rate hikes had caused global liquidity to tighten substantially. At the same time, credit expansion in China had slowed considerable as authorities clamped down on excessive borrowing, he said.

Tighter global liquidity was a large near-term risk to emerging markets as most of China’s foreign debt was $US-denominated. Investment and capital flows were eeversing out of emerging market economies and exacerbating the weakening liquidity in those regions.

China also recorded its first half-year current account deficit in 20 years in the June half year. If the deterioration continued without supporting capital inflows, China’s currency could depreciate sharply, Foster said.

A slump in China’s currency and a corresponding surge in the $US would be deflationary and a threat to global trade as other currencies would lose value.

“This is the key near-term risk to the positive outlook for the global expansion and equities.”

Foster warned any currency collapses and defaults by emerging market economies could result in financial contagion, a surging $US and the onset of deflation around the world.

*Dene Mackenzie is a Dunedin-based business commentator.

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Damian Foster of Forsyth Barr. Photo: Otago Daily Times.