Issue Number 32
December 2017

www.mcleandelmobentleys.com.au

Global investment cycle - where are we now and what are the risks?

The month of October often creates tension with investors given its historic track record with the 1929 and 1987 share market collapses. And it was in October 2007 that US shares peaked ahead of 50% plus falls.

From the post-GFC share market lows in March 2009, US shares are up 278% and global shares are up 196% to new record highs and Australian shares are up 92%.

After such strong gains it’s natural to wonder whether another major bear market is imminent. Leaving aside left field events triggering a major downturn, the critical question is where are we in the investment cycle at this point in time?

Second longest US cyclical bull market since WW2

The cyclical bull market in US shares is eight and a half years old. It’s the second longest since World War Two and the second strongest in terms of total gain. Typically the bull market phase lasts five years.

The typical cyclical bull market in shares has three distinct phases:

  1. When economic conditions are weak and confidence is poor – smart investors see value in shares.
  2. Optimism or the “sweet spot” – when profits and growth strengthen and investor doubts give way to optimism.
  3. When investors become euphoric on strong economic and profit conditions this will push shares into clear overvalued territory and leads to a new bear market.

Still in the sweet spot in the investment cycle

It is generally agreed right now that we are still in the “sweet spot” phase. Global economic indicators are strong, growth forecasts are being revised up as highlighted by the IMF, expected global GDP growth increased to 3.6% from 3.2% in 2016, this is driving stronger corporate profits.

Given the very slow post GFC recovery, there are still very few signs of the “euphoria” phase that ultimately leads to the market becoming exhausted.

The “sweet spot” phase is supported by the following important indicators:

a) There is no overinvestment globally. Whilst the US recovery is more advanced that most other countries, business investment and housing investment are around or below long-term averages relative to GDP.

b) Overall private sector debt growth is modest in most countries.

c) Spare capacity still remains after years of below trend growth globally. Technological innovation has constrained inflation, wages growth remains weak and has only recently picked up in the US. Core inflation in major countries ranges between 0.2% in Japan to 1.3% in the US.

d) Global monetary conditions remain easy and without a surge in inflation look likely to remain so. The US Federal Reserve is continuing to tighten but it’s “gradual” and from a very easy base and other central banks (including the Reserve Bank of Australia) are on hold. A shift to higher interest rates that brings about a global economic downturn looks a fair way off.

e) Share market valuations are mostly seen as reasonable value historically however shares are no longer cheap particularly in the case of US shares.

Australian share perspective — now versus 1987

Compared to 1987, the gains over the past twelve months have been more modest.

The 12 month lead-up to the 1987 market crash resulted in our local share prices gaining 88.4%, the last 12 months has resulted in a price gain or around 9.1%. Forward price to earnings ratios are around 15.8 times. This should be the case given far lower inflation and bond yields and real dividend yields are more attractive.

The local market has delivered modest returns so far in 2017, October 2017 was the stand out month.

Modest returns locally has been driven by Australian companies earnings growth results being well-behind global companies, disruptors entering the Australian Retail market and changes to Bank Regulations have unsettled our local market.

Investment implications

Corrections to market prices should be anticipated, with Trump, North Korea and the US Federal Reserve being potential triggers.

Despite the above issues we still appear to be a long way from the peak in the investment cycle.

Finally, non-US share markets and economies are less advanced than the US in their cycles and provide current opportunities for investors.

Key information has been extracted from the following sources:

AMP Capital – Oliver’s Insights Edition 31 – 18 October 2017

  • Franklin Templeton Investments – Global Macro Shifts with Michael Hasenstab, PhD Issue 8 October 2017
  • State Street Global Investors – What has thrown the Australian share market in 2017 20 September 2017

Ian Kinder
Director, Growth and Strategic Planning
AFS Licence Holder Number 245558

Important: This is not advice. Clients should not act solely on the basis of the material contained in this newsletter. Items herein are general comments only and do not constitute or convey advice per se. Also changes in legislation may occur quickly.

We therefore recommend that our formal advice be sought before acting in any of the areas. This document is issued as a helpful guide to clients and for their private information. Therefore it should be regarded as confidential and not be made available to any person without our prior approval.

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