IMF economic outlook suggests a defensive stance may be best
As the IMF (International Monetary Fund) annual meeting draws to a close a critic might ask about its usefulness? After all its economic forecasts may be detailed but rarely lead the market consensus and the IMF programme design is still suffering from serious questions about the Greek bailout. However, the IMF still proves its worth in one area namely reviewing financial stability. Phrases such as: ‘In emerging markets we are in the late stages of a credit cycle; there is about $3tn of over-borrowing or excess credit extended” certainly capture the attention! Is this all about China’s massive debts? The problems with Chinese indebtedness are substantial and well documented, but the issues go much wider, across an array of a dozen or so major emerging market economies and involve both sovereign and especially corporate debt.
Debt can be funded if company cash flow is strong. Sadly, the bigger picture is that the global profit cycle is getting tired. True, there are pockets of strength such as Europe and Japan. However, as the latest US earnings season shows, a combination of weaker global trade, currency moves, lower commodity prices, dis-inflation from Chinese excess capacity all add up. Initial expectations were that in the third quarter of 2015, S&P500 sales would fall by 3.4% pa year on year, the third consecutive quarterly decline. Earnings were expected to fall 5.1% year on year, the first back-to-back decline since 2009. Companies usually talk numbers down and then try to beat them, but the risk is that US profits barely grow year on year.
In the absence of decent earnings growth share prices are determined more by changes in monetary conditions. For this reason nuances within policy maker speeches are being over-analysed so small changes in wording can lead to large changes in the shape of the yield curve. Markets are volatile as they look for clear signals from policy makers to determine their next major move.
Some argue that all the bad news is in the price. Over the summer the spike in market volatility was as pronounced as it was 2010 or 2012, at the height of the existential debate about the future of EMU. Although the VIX index has fallen back our measures of financial stress, analysing credit availability, spreads or leverage across a variety of markets are all still flashing amber. This encourages our House View to remain defensively positioned into the autumn. Where we can, portfolios are moving up the capital structure, towards credit and away from equity. Sustainable yield matters, with the emphasis on sustainable.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Citywire Wealth Manager October 2015