Bull market may last, but how long?

The bull of Wall St in New York City. Photo: Getty Images
The bull of Wall St in New York City. Photo: Getty Images
The longevity of the current bull market will not be determined by a maturity deadline. Forsyth Barr broker Damian Foster tells Business editor Dene Mackenzie the bull market will be determined by the business cycle and the business cycle will be driven by profits.

Globally, the economic expansion remains intact, led by the United States, Forsyth Barr broker Damian Foster says.

Despite recent market volatility, manufacturing data confirms a moderating but still growing global economy.

Transportation and logistics activity were also consistent with global trade holding up, despite the negativity around tariffs and trade negotiations.

The second quarter reporting season in the US delivered earnings at all-times highs and profit margins continued to expand, he said.

With inflation remaining subdued, central banks would keep interest rates at accommodating levels.

As global growth expanded at a moderate pace, and inflationary expectations remained anchored, the current economic cycle could continue well into next year and possibly beyond.

Uncertainty and risks remained, particularly related to the US-China relationship, Mr Foster said; emerging market stability and the tightening of global liquidity as the US dollar strengthened were two.

"The growth outlook remains more compelling and we maintain our overweight exposure to global equities."

The domestic markets of New Zealand and Australia had challenging headwinds as business sentiment plunged while, at the same time, equity valuations remained at cyclical highs, he said.

New Zealand real interest rates remained some of the highest in the developed world. Softening business intentions made New Zealand higher-yielding securities attractive to domestic and global investors.

"It’s worth repeating the old market adage; bull markets don’t die of old age. They are usually killed by recessions."

The economic expansion remained on track and given what was known about the impact of tax cuts and deregulation in the US, further tightening of labour markets around the world, an absence of broad-based inflation and continuing stimulatory monetary policies from most central banks, there was a good chance the current economic cycle would continue.

Bull markets were driven by earnings and earnings tended to be pro-cyclical, Mr Foster said.

Some of the main points emerging from the recent US reporting season included revenue at all time highs, earnings at all time highs, profit margins at all time highs and widespread sector strength.

The market "bears", or pessimists, had worried about the flattening yield curve being an imminent sign a recession was approaching.

They had cautioned against an escalating trade war and expected rising labour costs and interest rates to hit profit margins.

"Peak earnings has been a common refrain, as has global debt and the age of the bull market. However, the current economic fundamentals remain supportive of equities pushing higher as economic expansion remains intact."

Leading indicators in the US — the yield curve being the exception — continued to record fresh new highs throughout July, Mr Foster said.

US gross domestic product growth was more than 4% annually.

Signs of progress in trade were were also encouraging. US President Donald Trump had called an end to the trade war with Europe. An agreement had been signed with Mexico and talks had resumed with China.

Rather than escalating, Mr Trump’s salvos might be starting to work in reducing overall global protectionism, something positive for global trade, Mr Foster said.

Earnings growth should fall below 20% next year, towards 10%, but it still represented growth and would push earnings into record territories. Equities could follow suit.

When companies "moving stuff" were doing well, it was often a confirming signal of health for the broader economy, he said.

In the US, the Transport Index had outperformed the Dow Jones index in the past year, 24.3% versus 17.9%.

Much of the credit went to the railroads. Rail car loadings, excluding coal, were at record highs.

"The volume of goods being moved around by trucks is also off the charts, thanks to the strong economy and the continued move towards internet shopping."

The multi-year surge in activity had led to capacity constraints in rail and trucking which had boosted cargo rates in land-based shipping, he said.

Excess shipping capacity had pushed down sea-borne freight rates and a global trade war would make the situation worse.

Going by activity in and out of the main US ports, all looked well. Activity at US west coast ports was at an all time high.

Looking at some of the global risks, Mr Foster said they centred on global liquidity and currency wars.Since the start of the year, many central banks had joined the Federal Reserve in lifting official cash rates. Most of those had been emerging market policy makers as they tried to stem their own currency weakness or manage inflationary pressures from falling currencies.

The combination of quantitative tightening in the US, and the repatriation of the US dollar following tax reform and rate hikes, had caused global liquidity to tighten substantially.

At the same time, credit expansion in China had slowed considerably as authorities clamped down on excessive borrowing in the Chinese economy, he said.

Slower credit expansion had contributed to a marked fall in local government investment in infrastructure throughout China. As property sales had fallen, the main source of revenue to fund infrastructure had also declined.

Tighter global liquidity was a large near-term risk to emerging markets, as most of their foreign debt was US dollar-denominated. Investment and capital flows were already reversing out of emerging market economies and exacerbating the weakening liquidity in those regions.

China also recorded its first half-year current account deficit in 20 years in the six months ended June. The trade war with the US was accelerating a longer-term structural change in China’s balance of payments.

If the deterioration continued without supporting capital inflows, China’s currency could depreciate sharply, Mr Foster said.A slump in China’s currency and a corresponding surge in the US dollar would be deflationary and a threat to global trade, as other currencies would also fall in value.

"This is the key near-term risk to the positive outlook for the global expansion and equities."

The divergence of growth between the US and the developing world in particular, the hiking of rates by the Fed and the withdrawal of US liquidity from the global economy was all adding to the structural risks in world financial markets.

At worst, currency collapses and defaults by emerging market economies in particular could result in financial contagion, a surging US dollar and the onset of deflation around the world, Mr Foster said.

dene.mackenzie@odt.co.nz

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