I trust you but cut the cards. –W.C. Fields
Supported by persistent monetary accommodation and some fiscal loosening, global growth continues to average about 3% annually. This is below historical norms, but it reduces earlier recession fears and momentum looks set to potentially improve in 2H16.
In Developed Markets (“DM”), there is likely bifurcation, with acceleration in US growth to contrast with a slowdown in Europe and the UK, even after some upward revisions to many market post-Brexit forecasts. China’s growth is holding up, supporting a broader, modest rebound in Emerging Markets (“EM”) growth.
The euro area economy was already slowing before the Brexit vote. Consumer spending had been losing momentum, while the recovery in fixed investment stalled in 2Q16. Confidence has stopped improving and some indicators point to further slowdown ahead, but the situation has not deteriorated as fast as pundits initially thought in the aftermath of the Brexit vote. However, elevated political uncertainty in Europe is likely to weigh further on already weak investment activity. Some countries remain exposed to a mix of political paralysis and weak banking sectors, in particular, Italy where the problem of banks’ Non-Performing Loans has not been resolved. In addition, as expected, the EU has not been able to formulate a constructive common strategy to respond to ongoing challenges, which have been exacerbated by the UK vote. Consequently, we still expect the economy to slow in the second half of 2016 and further in 2017.
While some global deflationary forces are fading, underlying inflation trends remain weak. The Fed may finally hike in December, but seems still highly divided. Meanwhile, the Bank of Japan and European Central Bank are approaching their limits and now face complicated decisions in the fourth quarter of 2016. US elections, political developments in Europe and growing financial vulnerabilities in China could eventually disturb the apparent calm in the global macro situation.
Cap Ex and Business Spending – A Ray of Light
Global capital spending appears to have moved back into positive territory and points to modest investment spending gains this Quarter. But with little improvement in global business sentiment thus far, the 2H16 recovery in spending is likely to be lackluster. In the US, rising capital goods imports point to equipment spending stabilizing following three consecutive quarterly declines. The latest Fed regional surveys show pricing power returning to goods producing industries – an encouraging signal for profits – but spending intentions remain depressed.
The capex slowdown that began in mid-2014 could initially be fully attributed to the collapse of the US energy sector. But since late 2015, non-energy capex has decelerated too. We find that some of the slowdown even in non-energy capex is likely related to commodity price declines and dollar appreciation. In both cases, capital spending is now likely through the worst of the drag. Tighter credit conditions, in part reflecting recent uncertainty about the growth outlook, might also have contributed to weaker investment growth over the last year.
One Bullish Case – Fiscal Policy and/or Private Capital Expenditures
Much has been made recently of the prospect of central banker’s monetary policy being supplanted by governmental fiscal policy (i.e., infrastructure expenditures, capital expenditure incentives etc). While this is possible, the current dysfunctionality in the US and unwieldiness of the EU make it tough, muted and delayed at best. Nonetheless, it is plausible. More credible, however, is that company capital expenditures pick up in the US once we are past the presidential election. Increased capital expenditures can drive greater efficiencies (margin), boost revenues (new business) and incrementally improve already reasonable job growth and consumption. All of this would be good for the economy and markets, but none of this plausible Bull Case is something we need or count on in order to make attractive investments in whatever economic and market environment we are given.
This Worrisome Market Ascent Can Persist as Only Recessions Kill the Bull
In a recent piece by UBS, they noted that “no bull market top of the past 25 years has been struck without a recession beginning within 12 months of the market peak; with 2Q16 growth tracking above 2% and seeing only a small probability of recession in the remainder of 2016 (they forecast GDP to grow 2%+) and 2017 (Growth forecast 2.5%) the (recent) S&P 500 peak is yet again unlikely to be The Top”.
Why Professional Investors Have Been so Wrong — The Fallacy of Looking in the Rear-View Mirror
We talked last month about this economic environment, markets as being Fat and Flat. Let’s understand what that suggests and why that is uncomfortable for so many in markets given their human frailties. We have only all seen and read of market booms and busts. After the Great Recession, we expected more of a, well, boom! The failure to get this boom has been off-putting to many. This failed expectation may be the cause of uncertainty. This uncertainty about the future makes most reluctant to commit aggressively to risk assets and tactical positions. At the same time, economic and market volatility is very subdued. This creates a conflict or even a contradiction, as the finance world almost uniformly measures risk about the future based upon the volatility of asset returns. Why is it that, with rock-bottom market and economic volatility, investors say they are so uncertain about the future? Perhaps because this feels unfamiliar when we look in the rear-view mirror at past markets and history and assume the road ahead is always what the road behind us looked like. Try driving a car with that philosophy.
We are not only in the slowest economic recovery since WWII, but also the most stable one. The volatility of global growth has reached a new record low. In round numbers, this recovery is so far, both half as fast as the average post-war one, and half as volatile. We know that slower inflation is generally more stable inflation, but had not directly expected the same of economic growth. It could be argued, though, that the same forces that are holding growth back from the supply side – lack of innovation and productivity growth – are also making growth more stable. More on this some other time.
Numbers and Narrative — The Road Has Changed and the Drivers Have Too
Statistics are used much like a drunk uses a lamppost: for support, not illumination. –Vin Scully
It’s my view that there is an emphasis on Numbers (valuation) over Narrative (the story) today, perhaps as irrational fears associated with lack of certitude, was further hastened by the Great Recession. The investment management business was already enormous in 2007, its ranks teeming with newly minted analysts with uber-excel skills. Virtually none of them and none of their modeling mattered in helping their employers avoid the wholesale carnage that occurred to investment assets in 2008. Further, those that did see the prospects of a market downturn, were primarily reliant, in my view, on Narrative. Nonetheless, the full-on freak-out of those that remained in the business (often younger as it was cheaper to cut expensive, seasoned headcount) lost their mojo – that is, being blindsided by the Great Recession translated into heightened probabilities of everything we look at going wrong, every qualitative connection, every assumption, every macro or industry trend being simply idle speculation unless quantitatively corroborated. In other words: there is no edge in that which was initially the only edge that great investors historically had – vision, perspective, reason, experience and gut. Ironically, then, the converse is true? That the edge is somehow in rote valuation work around publically available quantitative data? Can’t machines do this?
Numbers and Narrative must be inextricably tied. Narrative, however, is the driver. It is the look out over the windshield at the road before us. The notion of a plausible Revaluation Catalyst can only be thought of in terms of Narrative as the catalysts are simply, well, plausible. It may or may not happen. Our conviction level about probability is a function of the collective elements of our BRACE Methodology, and in all circumstances, variable and qualitative. Numbers are the arthropod, the exoskeleton that help us avoid wasting time, that help us maximize points of entry and exit. In that way, Numbers and Narrative are both essential. You can get into trouble without a command of both, but you will never make money in event-driven without Narrative providing the roadmap of what’s ahead. Narrative is forward looking, Numbers are looking in that rear-view mirror.
The above post has been excerpted from a letter of Tiburon Capital Management.
Watch Peter Lupoff discuss lessons learned from Izzy Englander: