The economic ship we are all sailing in can’t seem to decide which way the wind blows. Headlines splashing across computer screens from the WSJ, Bloomberg and the rest of those financial news agents have these conflicting tales of woe and stories of success. What’s evident in all this carnage is that the economy has undergone structural change, and markets are yet to figure it out.
There’s no doubt in my mind that we are on the precipice of a new era. The mixture of climate change, population, availability of information and fluidity through the world has us barrelling into unchartered territory. However, this isn’t new. History has seen these changes time and time again, and this time isn’t different. The real challenge though is trying to pick the winners and the losers amongst all this mess. It’s impossible to time the market exactly, but if we stop and look at some critical factors then maybe we can make a better investment decision and avoid buying at the top of the cycle or selling at the bottom.
In Dot Point
- High debt levels
- Strong labour market
- Stagnant wages
- Falling retail spending
- Low inflation
- Technological changes
- Realignment of the allocation of resources (Fossil fuels > Renewables)
- Good GDP growth
- Political uncertainty
- Increased business investment
The Global Outlook
Generally it is accepted that the global outlook for 2018 is a positive one. The U.S. has legs, the EU looks set to go and there is a general economic uplift. Recovery from the Great Depression of 1929 is argued to have taken almost 25 years which was eventually assisted by extreme government spending. The GFC is no doubt the most profound negative financial event since the 1929 and we are now about 10 years in to the recovery. Central Banks did an outstanding job of preventing the breadlines and keeping liquidity but it has left lingering distortions which are only now beginning to clear out.
The strong labour market conditions are driving optimism through the world. Sparking increased business investment and driving markets higher. This is all further support of Thomas Piketty’s concept that wealth grows faster than economic output. Irrational exuberance is making for frothy valuations but the real question is will these valuations become justified? The bears have naturally been casting negative aspersions and I’ve been hearing a lot of talk about the lack of wage growth given the strong labour market conditions. Well there’s a lot that can be said about this but for now, let’s keep it simple. Wage growth can only be expected once full employment has been reached. When firms can no longer tap into the labour supply at existing rates because everyone already has a job, then they will offer a sweeter deal, they will put the honey on to lure the workers from other firms. It is at this point that wage increases occur and we can’t expect them to occur sooner. We just aren’t at that point in the cycle yet.
Demand for goods and services is changing. It isn’t disappearing completely but it is shifting. Atlassian’s Cannon-Brookes often talks about how the race between software companies and industrials. Will industrials move into the digital age first or will software companies move into manufacturing. This epitomises how the market place is changing.
All in all the global outlook is a generally positive one and there is just cause for this. The underlying fundamentals are ticking upwards, the cycle is going up. I’d expect 2018 to start to bring back volatility as interest rate hikes, political events, and economic tail winds take some wind out of the sails temporarily, but I expect the markets will be higher at the end of the year along with better GDP per capita.
People are actually quite clever. So much so that economics has underestimated us for decades. With the rise of the internet people have been able to shop around more easily, compare products and prices and discover the best value. We are no longer restricted to the prices set by the stores in our local mall. If we want to buy an item on sale, we no longer have to wait until Black Friday or Boxing Day or Mid-Season sales. We can go sales hunting on Google. This is one of the key factors in the subdued inflation rate.
This isn’t the only factor affecting inflation but it is a significant one. It also demonstrates that inflation isn’t something to be concerned about. Markets and firms will eventually adjust to the new consumer demand paradigm and inflation will continue to rise at a steady rate.
The Household Bottom Line
It’s in our homes that things become challenging. Retail spending is subdued, high household debt levels, and high home prices create significant risk. A premature rate hike could derail households and the economic expansion. Or a large fall in house values could wipe out the wealth effect and put a holt to spending. It is with these risks in households that brings me to the next point and the driver for my investment objectives of 2018.
For years there has been weak business investment. Political uncertainty has hampered growth and firms have been recovering from the shock of the GFC. Now is the time for the firms growth though. Business is investing in technology such as AI, software, and energy. The technological growth in renewables and computers is about to pay dividends for the right firms.
In Australia the banks have given the bird to Parliament and said do your worst as they rid the environment of costly political instability. Similarly energy providers have gone off and sold fossil fuel assets and invested into renewables without any government support at all. In the U.S. firms are shaking off the infighting and nonsense to focus on growth and doing what is within their power.
Betting on suppliers of services and goods to business growth appears to be the play for 2018. Whether that be in a business that provides software, or hardware improvements, or fits businesses out with energy solutions, or restructuring firms, it appears that this is where household risk is mitigated and we can fill our sails on the general upswing.
The year of the of the dog. It will be a year full of excitement with Brexit talks, more elections, possible tax cuts, interest rate hikes and all sorts of political shenanigans. No doubt Bitcoin will remain the talk of the town, Elon Musk will continue to over promise and under deliver, and the markets will go on.
Mostly I am optimistic for the year. I believe it will be a stock pickers year and volatility will rise. There is significant risk in the household sector and that may tank a local economy but if appropriately managed by regulators and Central Banks then we should be in for a year of reasonable growth.
If I were looking at stocks to buy I would be looking for firms that are spending on efficiency, and self sufficiency. Firms that are scaling back on staff or reallocating them from menial and automated tasks to service focused and growth driven activities. High valuations are not of a huge concern for the right company but it’s always good to remember that the market goes through peaks and troughs.
If you have any questions then please feel free to comment, and if you would like any analysis or future articles examining an aspect of the economy let me know.