The economic outlook is “less than jubilant” and investors should be more conservatively positioned, according to an industry insider.
David Lafferty, senior vice president and chief market strategist at Natixis Investment Managers, sat down with WP to explain why he believes the global economy is likely to slow later next year and into 2020.
It’s the consensus view but he said it's not clear whether this has been priced into the market, with stocks still relatively expensive and credit spreads close to all-time lows.
It doesn’t look like the markets are worried but Lafferty pointed to headwinds that, combined, will result in the economy tailing off. Whether that becomes recessionary, he added, will depend on decisions made by the main policy-makers in 2019.
The biggest alarm bell for investors is the central banks raising rates, which is “no surprise”. However, Lafferty believes many have missed the significance of the real Fed funds rate turning positive after being negative for eight years.
He said: “I use this to push back on people who say the Fed has been raising rates for almost three years, starting September 15, and the stock market has [still] gone straight up. Well, that’s because real interest rates have gone from absurdly negative to just gradually less negative. But now we are crossing over into actual positive territory.”
The neutral rate is thought by many regional US banks to be around 3%, which means it’ll likely be reached in the second half of next year. “This will pass the line when policy goes from accommodative to somewhat restrictive,” Lafferty said. “One could argue that the February volatility sell-off and the current volatility sell-off are both directly related to that dynamic. There was no geo-political event that happened in the last week of January, for example.”
Second on Lafferty’s laundry list of headwinds is the natural fading of President Donald Trump’s US corporate tax cuts after the 2018 “sugar high”. He said the lack of investment back into business and the fact CapEx does not seem to be outpacing the cuts suggested the effect is wearing off.
The mid-term elections offer yet another likely gridlocked scenario, with the Democrats likely to gain control of the House of Representatives in November.
Lafferty said: “This means there’s going to be no more fiscal impulse. If all the pollsters are wrong, the stock market will go through the roof because the [Republicans] will make the tax cuts permanent and make more.
“But that isn’t what most people think will happen. You’ll get gridlock. If the Democrats take the house, the only two things that are going to happen in the next two years with the Trump administration is campaigning for the next election and dodging congressional subpoenas.”
Lafferty pointed to four more global developments that have the collective potential to drag the economy down. Brexit, he said could be anything from a minor supply chain shock to a catastrophic one with inflationary pressures. Regardless, it’s already a headwind for the UK.
Rising oil prices and strong US and Canadian dollars will both suck liquidity out of the system, while China’s managed slowdown is in progress and the trade tension between them and the US – which Lafferty believes is more about industry policy than anything else – isn’t going away anytime soon.
So what should an investor do with his self-proclaimed “less-than-jubilant” outlook? Lafferty believes this is not the time in the cycle to be overly aggressive or overly defensive but to examine your risk tolerance and asset allocation.
He said: “We’re not to the point where we are bearish or telling clients to get out of the market. It turns out that from a probability standpoint, telling people to be bearish or to get out of the market is bad. The stock market tends to be up about 60-70% of the time, whether it’s daily, weekly, monthly or quarterly.
“It feels too early to tell people to get super defensive. We’re telling them to ease back a little bit, be around their long-term normals. Maybe if you’ve been in the market and been participating for 7-8 years in the global equity run and interest rates have been suppressed in both stock and bonds, it’s time to take some of those gains.”
He added: “Long story short, now is the time to be more conservatively positioned, lower beta, less downside and hold on to your hedges.”
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