Investment Outlook for May 2019
MAINTAIN THE EQUITY COURSE
Looking back at the first quarter of 2019 one could observe that the spill-over of uncertainty in financial markets from the end of last year, volatility in US retail sales and the labour market, and the lack of clarity regarding Chinese policies all evaporated as major worries affecting global equities, enabling investors to focus on earnings trends without major short term distractions.
The overall investment conclusion for Dominion’s Funds remains that, reflecting structural economic policy adjustments, monetary authorities are now entrenched in an accommodative stance and currently only major economic shocks seem to be able to change the minds of central bankers.
As major equity indexes are close to record levels, short term equity investors are, as a consequence, facing a dilemma: lock in the impressive recent gains or maintain the existing equity exposure. We think that fundamental economic trends justify a continued exposure to a selective portfolio of superior growth stocks, and that investing according to GARP (Growth At a Reasonable Price) principles continues to offer an attractive relative performance outlook for the next 12 months without the need to move up the “risk curve”.
The S&P 500 is on track for the best four-month start to the year in more than three decades, posting a ca.19% gain and moving close to a record. The index’s surge surprised many Wall Street banks that expected a much slower rebound from last year’s downbeat finish.
How is it possible that under current economic trends equities continue to perform favourably? This question has become louder over the last month. A number of commentators have suggested that central banks must be looking to cool the economy now that the risk of an imminent recession has evaporated. According to this orthodox line of macro-economic thinking inflation must be tamed before it becomes a menace (similar to what happened in the early 1980s).
Is there really a trade-off between employment and inflation?
The time might have come to re-assess the popular notion of a perceived trade-off between employment and inflation: it would be great if one could engineer an economic policy that generates both low inflation AND low unemployment. It seems that 2019 is rapidly evolving as an important year for innovative monetary policy.
Not a lot has been written by academics regarding policy prescriptions addressing current macro-economics.
A (very) short summary of an article by Gavyn Davies in the FT of May 25 2015 provides relevant insight in an emerging theory that explains recent economic trends rather convincingly. In that article he states that a number of economists have been arguing that the level of real GDP is actually much higher than shown in the official statistics, because the inflation rate is really much lower than the consumer price index figures suggest (if you correct reported GDP for inflation the result is real GDP). Lower inflation, for any level observed GDP growth, implies higher real GDP growth. A relatively small number of economists (Martin Feldstein being one of them) suggest that the official statisticians are underestimating the rate at which technological change is improving the quality of what consumers are buying (iPhones, flat-screen TVs etc). In principle, the improvement in the quality of a good should be taken into account by statisticians recording economic trends, but in practice Mr Feldstein says, this represents an “impossibly difficult” computation. Despite these difficulties, he expresses the view that estimates of growth in GDP and real income fail to reflect the remarkable innovations in the economy in everything from health care to internet services to video entertainment that have made life better in recent years.
If the genuine inflation rate were to be lower than the reported rate, monetary policy should stay easier for longer. A key issue in 2019 therefore remains: how will monetary authorities adjust their policies to take account for low inflation caused by technological advances (ecommerce etc)? If they do not react there is a danger of inflation over-shooting before any policy tightening happens; there is no immediate danger of this happening but any sudden acceleration in inflation could have profound investment implications.
It is tempting to summarise recent economic trends as follows: technological advances boost economic welfare (output), which initially remains “hidden” from statisticians. Inflation statistics are recorded for “outdated” consumption baskets and old production structures at the macro level. To explain this in another way: modern technology boosts the supply of goods and services and, as a consequence, suppresses macro price increases. In addition, the application of modern technological processes has the effect of boosting the availability of labour in the economy (an important effect of the “gig economy”).
Central banks are coming around to the incorporation of these recent insights into their policy considerations, although there is a lack of formal incorporation through new economic models and adjusted statistics. The regional FED in Dallas, for instance, stated that short term interest rates are where they “should be” and that it was too soon to consider cutting US interests rates (interesting to note that the topics of public discussion on monetary policy has moved from tightening and normalisation to potential loosening).
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The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Fund Management Limited. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.