Cyclical views and structural blues

Our incoming CIO, Anton Eser, talked on Bloomberg about the structural imbalances in the world. In my view, this is a ‘must see' clip for every investor. While we agree that these imbalances exist, here are some additional factors to keep in mind.

Anton and I share a deep passion for analysing the medium-term structural problems in the world, caused by the gigantic debt build up (especially in emerging markets) and demographics.

 

We agree on the structural backdrop, as I mentioned for instance in A Postcard from Beijing.

 

In our view, the big question of the last few years is not if the China risk will materialise in a chaotic way, but when

 

Based on these structural issues, Anton expresses a very bearish outlook on markets: asset prices are by no means priced for a recession that coincides with a deep correction of the credit cycle. Our medium-term view is similarly one of caution on risk assets, based on the structural risks.

 

However, when thinking about markets in 2017, we are mindful of three other things:

 

  1. Short-term timing based on medium-term trends is very tricky. In this respect we like this quote from Bill Gates:
    We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.
  2. Mediocre growth combined with massive central bank liquidity injections has been “good enough” to support risk assets for the last five years. We are therefore collectively focused on what can break that regime. Anton identifies a further bout of dollar strength as one mechanism that could meaningfully tighten global financial conditions. In previous posts, we’ve discussed the potential for a change in leadership at the Federal Reserve, or an acceleration in Chinese capital outflows to drive the dollar higher.
  3. The economic recovery may be on life support, but it is not dead. Weak growth accompanied by soft wages could extend the length of the cycle if it puts off the build-up of capacity pressure and delays monetary tightening. Given that economic cycles don’t die of old age, we spend a lot of time considering the cyclical outlook. James Carrick’s thoughts on the recent stabilisation in credit conditions are well worth reading in this context.

 

We all need to think carefully about the structural blues outlined by Anton, while recognising that getting short-term views right is exceptionally difficult. I am less convinced that a severe structural correction lies in store in 2017, but delaying the pain risks creating even more trouble further down the line.

 

Watch Anton’s Bloomberg interview in full here

 
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