Investment View Q3 2015
What causes long term bull markets to stay intact?
The very simplified answer is; to be in an economic environment with the right balance between inflation, wage increases and productivity. Without wage increases consumer demand cannot grow, without productivity companies cannot afford to pay higher wages. With low input costs, together with higher productivity, profit growth of companies should be good.
With the absence of external shocks, we believe that a number of factors both in the U.S. as well as in Europe are coming through that support the argument that we may indeed be in a long term bull market for western stock markets (with the Eurozone entering a bull market).
For the first time in almost ten years, wage growth is returning to the U.S., the UK and Germany. All three countries are close to full employment which may explain the growing pressure for wage growth. Japan is trying to increase wages but so far has failed to convince Japanese companies to act.
Input costs are down significantly due to historically low commodity prices across nearly every commodity sector (iron ore is at a 150 year low). Cost of capital, although this may go up somewhat, should stay structurally low for quite some time.
To this positive scenario, the fundamental issues facing China and higher US rates are the biggest risks.
At this stage in the cycle China faces three bubbles simultaneously, in credit, real estate and equities. The Chinese central government is trying to engineer a soft landing at a time the country’s economic growth model must change from an exporting to a consumer oriented economy. China, the second largest economy after the U.S., is an important buyer of goods produced by many western companies or EM countries (commodities). A hard landing of China’s economy would leave a big demand vacuum with disastrous effects on many companies’ results.
The best strategy is probably to concentrate investments in companies that are immune to China’s potential woes.