Investors must keep eyes on business cycle


After a rather disastrous December, equity and credit markets worldwide rebounded swiftly in January.

Investors may feel sceptical of the recent bounce, but we believe it is vital to take a step back and look at the bigger picture of where we are and how market participants are pricing financial assets at this current juncture.

The performance of various asset classes and market segments will differ depending on which stage of the cycle a country’s economy is in.

Taking a global approach in investing requires understanding of where the various economies are in their business cycles in order to position portfolios appropriately.

Economic data such as labour market statistics and capacity utilisation data are great starting points to measure which stage of the business cycle an economy is in.

The data sets currently suggest developed economies are somewhere in their middle- to-late stages of the business cycle.

The current trend is not yet suggesting a deterioration in productive capacity. Although the US economy is expected to grow slower in 2019 compared to 2018, the chance of a recession (defined traditionally as two consecutive quarters of negative quarter-on-quarter growth) this year are slim as domestic consumption and business investment remains robust.

Hence, until the trend turns down, growth remains supported.

In Europe, although there has been a deceleration in growth momentum, the economy on the continent continues to be supported by domestic consumption.

Credit growth remains robust and supports investment and spending in the current cycle.

Furthermore, the traditional signs of optimistic excitement that typically accompanies cycle peaks are difficult to find at this juncture.

In fact, we have witnessed euphoria and froth taken out in certain segments of markets, such as the hype surrounding cryptocurrencies and the cannabis industry in North America.

In regards to emerging markets (EMs), the various business cycles are not as synchronised or in similar stages to one another.

China, the largest EM economy, remains a huge driver of growth in the EM universe, but its economic growth rate is expected to gradually slow as policymakers prioritise the quality of growth.

Countries that rely heavily on the “Red Dragon” have seen a cooling in growth momentum.

However, we opine that China’s policymakers will ensure growth on the mainland will not fall off a cliff and Beijing has, thus far, rolled out a series of measures to ensure growth remains supported.

Any resolution in the China-US trade dispute could lead to a recovery in business confidence and investment sentiment, which would contribute positively to growth prospects.

Understanding cyclical-to- defensive ratios in equity markets are one way to gauge how market participants view the future.

The magnitude of the decline in such ratios were relatively pronounced for all regional equity markets, as market participants de-risked and piled into the defensive segments.

Within the cyclical sectors, forward valuation multiples of certain segments are at levels not seen since four years ago, indicating growth expectations have drastically fallen.

Valuations have massively de-rated, and what could be inferred from this is that the speed and magnitude of the recent de-rating in valuations were comparable to those of previous bear markets, whereby we either saw an implosion of bubbles or an outright financial crisis.

Based on market internals and the rapid and huge valuation de-rating at this current juncture, it is possible investors may have overreacted, creating pockets of opportunity in the process.

Despite a rebound in risk-assets in financial markets globally, investor sentiment remains poor at best.

Investor sentiment and expectations have completely reset from where they were 13 or 14 months ago.

A simple scan of financial news over the past few weeks or months reveals an abundant number of articles spelling “gloom and doom” and forecasters calling for market crash or crisis. This was what exactly happened in end-December 2018.

The general reset in investor sentiment levels is a positive for risk assets and adds fuel to any recovery in risk-assets as the vast majority of market participants may not be positioned for it.

At this juncture, we are overweight equities vis-à-vis fixed income for our asset allocation in 2019 (55%:45%).

Overall valuations have improved from where they were 12 months ago, and relative to bond markets, equity markets remain more attractive as earnings yields are higher than where we expect fixed income markets to trade at in 2019.

While we remain positive on emerging Asian equity markets relative to developed markets, we prefer the north and east Asian countries within the Asia ex-Japan region.

Valuations have de-rated massively and pockets of value have opened up consequently.

As for developed markets, we are more positive on Japan compared to the countries of the eurozone and the US.

Although we are not as positive on the South-East Asian equity markets in general, there are very favourable structural trends supporting growth prospects, offering investors plentiful of opportunities.