This business cycle, while not particularly strong, has become one of the longest on record. While this varies from country to country, the US as a major global economy has been in an expansion phase of the business cycle since bottoming around June 2009 – that is more than 10 years.
Part of the reason is that central banks’ stimulus proved more effective than opponents predicted, and it would seem that their actions may extend the duration of the current cycle. Markets have become dependent on these stimulus measures to a large degree.
At the start of 2018, a bad outcome for the year was not expected in view of the positive anticipations and forecasts at the time. However, many asset classes were pummelled during 2018 with returns mostly negative or flattish at best. Investors largely blamed the unwinding of the US Federal Reserve’s stimulus and tightening monetary policy for rattling the markets. On the back of a negative 2018, the bullish sentiment of many market pundits was knocked with the outlook for 2019 looking quite uncertain if not negative; albeit that there were some who believed that the prospects of a positive 2019 were improved in light of the selloff in late 2018. After a shock decline in equities in 2018, economic growth in many economies also deteriorated unexpectedly quickly with inflation falling. Yet to the contrary, 2019 panned out much better on the market return front with bullish sentiment spilling over into 2020.
On the back of this positive mood for markets, 2020 started strongly with forecasts generally positive for the year. One cannot help but ponder the tendency of human nature to extrapolate current or recent experience. Will 2020 vindicate the prevailing mood or be another year of surprise as far as market returns or outcomes are concerned? The US bond market, for example, has experienced a bearish run since its previous bull market top and has not yet reversed this decline. However, stock markets have pressed ahead through the wobbles with a number of major global indices registering all-time highs. 2018 now seems to have rather been an unwelcome bump along the road of an otherwise long-term positive stock market trajectory, especially in the US. The onset of 2020 is enveloped in “let the good times roll” (at least for now), especially as many expect an improvement in the global economic environment this year. It is interesting that a weakening economic backdrop in 2019 has not negated a positive market outcome. Will improving economic conditions in 2020 as projected by many mean more of the same, or end contrarily? In light of experience, it should be borne in mind that markets tend to lead economic outcomes as they discount the future. As the world is ever in a state of flux, we note some issues that may play a role in affecting outcomes for this year.
Influencing factors for 2020
On the political front, the pro-democracy protests in Hong Kong may continue, impelling the People’s Republic of China to take action. American voters will go to the ballot box in November and the outcome will have implications for the years ahead, especially what it implies for global trade relationships given recent trade wars. The euro area faces its own challenges of how best to stimulate a weak economy and keep the Eurozone project afloat in the face of increasing nationalistic fervour. Potential geopolitical risks remain given tensions and flare-ups from time to time, the Middle East being a recent case in point.
Global warming has been under the spotlight with issues of devastating fires in the Amazon (Brazil), California and Australia. These, along with more floods and droughts like those experienced in places like South Africa, India, Nebraska and Iran, will have major implications for economies. This is at a time when commitment to the Paris Agreement on Climate Change (195 signatories) seems uncertain when gauged by the disappointing conclusion of a United Nations climate-change conference in December 2019.
Recent monetary stimulus from global central banks and an easing of financial conditions have contributed to improved prospects. On the economic front it is expected that the global outlook will improve modestly in 2020 as activity bottoms out and growth stabilises, especially with a number of previous downside risks now resolved. It is uncertain whether growth would be strong enough to generate inflation or compel some policy tightening. More countries now seem to be at a stage of recovery in the cycle rather than in a slowdown. This is believed to be a favourable phase for risk asset performance, but stretched valuations would limit the upside.
An important question is whether stimulus provision – easier monetary policy, central bank balance sheet expansion and concomitant global liquidity – could be sustained and continue underpinning the market, or whether it risks fading. No doubt, liquidity is and has been a key driver in the fortunes of markets and central banks have been instrumental in keeping the show on the road. We have yet to reach a stage where the global economy and markets have weaned themselves off the need for continued stimulus measures. As noted, the Fed’s attempt at continuing to normalise the policy regime had been met by faltering markets which impelled them to revert to stimulus. The big question is whether the Fed (and thus other central banks) can sustainably and indefinitely orchestrate desired market outcomes, and do so without major repercussions down the line. There is a risk that the relative success of monetary policies since the Great Financial Crisis of 2008 may breed some mistaken belief in their invincibility. However, the fear of the opposite outcomes, such as deep recessions or deflation, is enough to keep them stimulating while they can rather than capitulate.
In conclusion, thanks to central bank stimulus, the current business cycle largely continues. If countries run out of monetary ammunition, fiscal policy measures may increasingly be called upon. One big question is for how long these interventions could be sustained and keep markets happy. Be assured that markets will be the first to show and tell if they start losing faith in central banks.
Fabian de Beer is the director of investments at Mergence Investment Managers.
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