“It matters a great deal who is going to win, but not at all who won.” – Willie John McBride
No man’s land
As we nervously pace the no man’s land between the first round and the second round of the French presidential elections, many continue to wonder about the health of the world’s economy. Surveys of the private sector – especially in the US – have been telling us since last summer that brighter times lie ahead, but what of the so called ‘hard’ economic data: actual production, consumption and corporate earnings? With President Trump’s newly announced tax plan/memo sure to get bogged down in the congressional mire, in spite of all the sound and fury, the extent to which this survey strength translates into tangible economic upside will be key to the path of capital markets for the rest of the year.
Those arguing that the surveys are a mirage to be ignored by the astute investor tend to point to a variety of ways in which the activity of filling in these surveys is open to abuse: companies lack the time, incentive or up-to-date information to complete them accurately; respondents may game the system to try and tilt the policy backdrop in a more favourable direction; For such sceptics, rosy US private sector sentiment is overly dependent on a president with sagging approval ratings unlocking a persistently recalcitrant congress. Therefore, the critics say, recent moves in bonds and equities are not to be trusted, and the underlying world economy is just as sick and distorted as it appeared to be last year.
While some of these criticisms of survey data may indeed be true, there is an easy way to find out whether we should still listen to them. We simply have to ask ourselves whether there has been any weakening in the ability of surveys to predict the hard economic data that traditionally follows. Happily, the statistics argue that these surveys, particularly those more august such as the ISM, remain formidably trustworthy. This suggests that our continuing faith in the cyclical prospects for the world economy remain well placed.
Hard data already rising
This debate is becoming increasingly moot in any case. First, this whole line of thinking seems to ignore the fact that sentiment indicators have not just been picking up in the US, but all around the world, and have been doing so since well before the US presidential elections. More importantly, the hard economic data, such as industrial production, corporate earnings and trade statistics are already rising briskly around the world. In both emerging and developed economies, hard industrial production data has broadly risen in tandem with the manufacturing surveys. First quarter GDP data in the US may seem to support the doubters, but lingering seasonal adjustment problems could well be continuing to obscure the underlying trend in output growth.
All this provides important context for still buoyant global stock markets, suggesting they are less precariously placed than some argue. Of course, pull-backs in risky assets are always around the corner. However, those same surveys tell us that the positive trends seen in the ongoing first quarter earnings seasons both sides of the pond are in their infancy. We expect stock prices to continue to follow suit. For their part, bond bulls have clearly not thrown in the towel yet, perhaps not surprising given the persistent declines in yields seen over the last several decades. It will take a lot more than this admittedly nascent upswing in hard economic data to convince them that the life long bond bull market (in many participants cases) may finally be running out of steam.
US tax reform, if it does make it through the congressional treacle, would be a cyclical cherry on an economic cake that already looks pretty appealing for investors. We are not reliant on its enactment to support our current mildly pro-risk tactical posture. We are admittedly a little more nervous of the second round of the French presidential election than the market seems to be – the tea leaves from the first round do not make for particularly relaxing reading. Nonetheless, we still do not quite see sufficient probability of a Le Pen presidency to take pre-emptive tactical action; particularly not in the context of those legislative elections in June, which will likely act as a significant constraint on either Le Pen or Macron’s policy ambitions. The message remains the same – stay the course; equities look the most attractively priced means of playing that improving global growth picture, while high quality bonds continue to look set for a period of return-free risk.