Four of the six top fund managers in the world are asking their clients to be cautious in 2018, with one even asking them to watch out for a pre-recession build-up. From overheated assets to a weaker dollar, here’s what they see.
Scott Minerd
The chief investment officer at Guggenheim Partners, which manages assets of $240 billion, is betting that the next recession is most likely in late 2019 to mid-2020.
It is therefore critical for investors to have a well-informed view on the business cycle so portfolio allocations can be adjusted accordingly. At this stage, with the current US expansion showing signs of ageing, our focus is on projecting the timing of the next downturn.
Guggenheim said macro-economic conditions are mirroring the indicators prevalent 18-24 months ahead of the past recessions. Looking at the current cycle...
- The labour market is in early stages of overheating. It sees unemployment heading to 3.5 percent, consistent with the pre-recession behavior in past cycles.
- It expects the Fed to step by hiking rates to cool the labour market and get ahead of inflation, only to push the economy into recession.
- The steady increases in the Fed rate will continue to flatten the yield curve over the next 12-18 months, an indicator usually occurring about 12 months before the downturn begins.
- The Conference Board Leading Economic Index growth of 4 percent has been on a par with past cycles two years before a recession, and it will be closely watched for a deceleration in 2018.
- Work hours will slow ahead of recession. Aggregate work hours have been steady, though weaker than average levels, indicating slower labour force growth as baby boomers retire. Hours worked is expected to hold up in 2018 before slowing more markedly in 2019.
Howard Marks
The co-chairman of Oaktree Capital Management, which manages assets worth $100 billion, advises caution in the year ahead. Easy money has been made but risk assets are not heading for a collapse or a crisis, he said.
According to Marks, the four most noteworthy of the current conditions are...
- The uncertainties are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.
- In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.
- Asset prices are high across the board. Almost nothing can be bought below its intrinsic value, and there are few bargains. In general, the best we can do is look for things that are less over-priced than others.
- Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.
Marks also questions the high valuations of the technology companies. “That raises the question of whether investors in technology can really see the future, and thus how happy they should be paying prices that incorporate optimistic assumptions regarding long-term earnings power. Of course, this may just mean the best is yet to come for these fairly young companies.”
Jeff Gundlach
According to Gundlach, the economic data continues to surprise to the upside both in the US and globally. The Fed continues tightening in the ‘double-barrelled’ fashion— both raising interest rates and quantitative tightening.
- He does not see signs of recessionary indicators.
- Dollar will weaken another leg down, but would be surprised to see a slight uptick in the short term. A weak dollar will be consistent with the commodity prices going up.
- Dollar weakness will cause gold to move up as a ‘safe haven’, which will further drive the commodity prices higher.
Richard Turnill
Richard Turnill, the global chief investment strategist BlackRock that manages nearly $6 trillion, does not believe a flatter US treasury curve is a recessionary indicator. He sees this as a result of reversal of 2016 steepening that accompanied surging growth and inflation expectations after the presidential elections.
Turnill is positive over a next three months for the dollar.
- US earnings momentum is strong heading into 2018. Corporate tax cuts could provide an extra leg-up.
- In Europe, he sees sustained above-trend economic expansion and a steady earnings outlook supporting the cyclicals. Euro strength is playing out in earnings but it is expected to be less of a drag.
- Economic reforms, improving corporate fundamentals and reasonable valuations support emerging market stocks. Risks include a sharp rise in US dollar, trade tensions and elections. He sees opportunity in Brazil and India while is cautious on Mexico.
Bill Gross
Prior market peaks allowed fund managers to partially “insure” their risk assets by purchasing Treasuries. But, today that “insurance” is limited with interest rates so low. “Risk assets, therefore, have a less ‘insurable’ left tail that should be priced into higher risk premiums,” he said.
Gross said money or cash is different than credit. “High-quality credit can at times take the place of money when its liquidity, perceived return, and safety of principal allow for its substitution.” But when the possibility of default increases and/or the real return on credit or liquidity decreases and persuades creditors to hold classical “money” (cash, gold, bitcoin), then the financial system as we know. It can be at risk (insurance companies, banks, mutual funds, etc.) as credit shrinks and “money” increases, creating liquidity concerns, he said.
Jeremy Grantham
Jeremy Grantham, the co-founder of Boston-based GMO which manages $120 billion in assets, says that the trend line will regress back toward the old normal (pre-2008) but at a substantially slower rate than normal because some of the reasons for major differences in the last 20 years are structural and will be slow to change.
He advocates being heavily overweight on emerging market equities, own some Europe, Australasia and Far East and avoid US stocks. The cycle for resources has turned, global economies are doing quite well by recent standards, and oil prices are likely to rise for three years or so.
Be as brave as you can on the EM front. Be willing to cash in some career risk units. Bravery counts for so much more when there are very few good or even decent alternatives.Jeremy Grantham
(This piece was originally published in BloombergQuint and has been republished with permission.)
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