Positioning for the Late Stages of the Bull Market: 2017-2018

Over the 12 months to mid-2016, global equities witnessed abnormal volatility driven by both macro and micro concerns. This reflected a more complex investment setting.

One symptom of this complexity has been the perceived inability of U.S. and Chinese central banks to provide the leadership upon which markets have historically relied—with the former forestalling short-term interest rate increases and the latter depreciating its currency. Meanwhile, in Europe, the credibility of the political establishment has been challenged by the migration crisis and Brexit. And industry-specific travails in the German auto and Italian banking sectors provide a reminder of how quickly corporate fundamentals can change.

A More Positive Storyline Unfolds

In contrast to the consensus, which appears unduly pessimistic, we see a more normalized storyline in coming years. This reflects our belief that:

  • Global GDP growth is bottoming and could surprise positively through 2017, supported by ongoing U.S. expansion, European recovery and stabilization in emerging markets. Equities will anticipate a positive inflection in the earnings cycle if the global economy gradually improves.
  • Equity malaise in 2H 2015 and early 2016 reflected a profit recession (oil, commodities, emerging economies, USD strength) that appears to be ending. An improving earning cycle will reframe the past 18 months as typical of a mid-cycle U.S. slowdown.
  • Post-Brexit, there has been a rotational shift in the markets that we believe is supported by improving cyclical fundamentals. As shown in Figure 1, the U.S. Economic Surprise Index has painted a generally negative economic view. More recently, however, the index has turned up.

Figure 1. Improving Fundamentals Have Driven The Cyclical Rally

Past performance is no guarantee of future results. Source: Empirical Research Partners using Citigroup, Federal Reserve Board, Empirical Research Partners Analysis.

The U.S. Matures: 60 is the New 40

  • Recession risk for the U.S. remains low until 2018/2019. While the U.S. expansion is old in time (8 years), it looks more “midcycle” (fourth or fifth year) in terms of the fundamental improvement in wage growth, capacity utilization, capital spending and so forth.
  • The U.S. household sector has sailed through this “global earnings recession,” supported in part by the sharp decline in oil prices. Equally, the absence of consumer durable or credit excesses explains the unusual health of U.S. households (Figure 2) at this stage of the expansion.
  • U.S. consumers have only just “dug themselves out” of the equity sinkhole that arose from the Financial Crisis. Rising levels of home equity (Figure 3) provide a tailwind to consumer activity and can sustain the current recovery cycle. As consumer balance sheets normalize, could the coming years witness a more typical consumer in terms of spending on durables and housing?