Archived News 18/07/2018
Will Positive Earnings Risk outweigh Negative Political Risk?
The outlook for equity markets, in our view, is surprisingly positive. However, the summer months could be challenging for asset prices as there is a confluence of political events which could knock investor confidence...
The main reason we are optimistic about the outlook is that we believe that productivity is about to improve significantly in the United States (in particular). If correct, economic growth in America will likely persist for longer than currently expected without stoking troublesome increases in core inflation and interest rates.
...the summer months could be challenging for asset prices as there is a confluence of political events which could knock investor confidence.
Our opinion that productivity is about to improve is at odds with the prevalent view. We are optimistic because company management teams are becoming increasingly confident (and vocal) that there are real productivity enhancements available to them via investments in technology enabled by digitalisation. Importantly, this spans both manufacturing and service companies.
This thesis chimes strongly with the experience of the mid to late 1990s when the United States economy was judged to be operating at full capacity, wage inflation was accelerating strongly but core inflation was well behaved as productivity grew impressively.
Given this dynamic, we believe that large companies will be able to absorb inflationary wage pressures, however there will be periods where this will be questioned as the two (productivity growth and wage growth) will not move in lock step. This means that equity market volatility will be heightened, however we believe the overall direction of travel for equity markets will continue to be up.
In the near term, however, a variety of potentially confidence sapping political events appear to be close to conclusion. The common theme would appear to be ‘de-globalisation’.
President Trump would appear to be intent on increasing the scale of Chinese goods caught by trade tariffs as well as implementing tariffs on imports of foreign built cars.
As at time of writing, President Trump would appear to be intent on increasing the scale of Chinese goods caught by trade tariffs as well as implementing tariffs on imports of foreign built cars. If he does follow through with these threats, China will respond asymmetrically by slowing customs clearances and weakening the Chinese currency. This has the potential to escalate and could knock investor confidence.
...the impact of tariffs on global growth, whilst negative is likely to be manageable and the inflationary pressures that build, as a result, modest.
In reality, however, the impact of tariffs on global growth, whilst negative is likely to be manageable and the inflationary pressures that build, as a result, modest. Furthermore, multi-national companies are highly adaptive and provided supply chains aren’t too badly dislocated, swift management action will ameliorate some of the impacts. Nonetheless, working capital requirements are likely to rise as companies carry more stock and component prices increase.
Should such a situation materialise, the private sector in the United States will swiftly publicise the negative impacts that the trade war is having and the electorate may well begin to notice some consumer goods prices rising in ways they weren’t anticipating. This should bring pressure to normalise trade relations ahead of the US mid-term elections this November. We, therefore, believe that the negative impacts of the developing trade tensions and the uncertainty engendered as a result should be relatively transitory in nature.
Cornelian Investment Team