“Economic expansions do not die of old age, they die because there is some kind of imbalance in the economy,” Budden said at a media briefing in Hong Kong today. “We don’t see any sign of imbalances.”
“2018 is likely going to be a good period for risk assets, equities in particular,” he said.
The global economic expansion, which has gone on for 100 months, almost double the usual length, has been steady and measured, he noted, adding that significant pressure points that could bring on a shock and lead to recession have not developed.
The continuing growth has solid support in new technologies. Booming e-commerce in China likely has helped the country to avoid a “hard landing”, while corporate profits continue to grow healthily in the US and Europe.
A mild correction?
Although the overextended market cycle – “an extraordinary period” in Budden’s words – is showing no sign of ending, high valuations in several markets are likely to bring on a correction and increased volatility.
High valuations in themselves are not that worrying, according to Budden, who said he did not see any market bubbles about to burst. Companies with high valuations actually deserve them, since they have been delivering solid earnings growth, which is expected to continue. Those that do not deliver see their stocks punished.
“Markets have been quite rational,” Budden said. “You don’t see junk companies doing well. We find it reassuring.”
Despite historically low volatility and high valuations, Budden doesn’t see complacency among investors. “Everyone I speak to is worried,” he said. A correction would bring a measure of normality to the market. People want a correction to put more money in the market, he added.
A market correction, when it comes, is most likely to be mild and short. “In absence of recession, bear markets are not severe,” Budden said. Nevertheless, he expects volatility to increase, but does not expect “really nasty declines in equity markets”.
Watching high yield
In the low interest environment, many investors have been gradually migrating their fixed income portfolios toward more risky corporate and high yield bonds. While credit fundamentals are still strong, valuations are “quite stretched” and bond holders are no longer adequately compensated for taking on this additional risk, Budden said. Moreover, should equities drop, many high-yield corporate bonds will suffer too.
It is time now to readjust those risky high-yielding portfolios of corporate bonds and position them to “behave as a bond portfolio should” – doing well when equities do poorly.
While generally optimistic about the economic outlook for 2018, Budden noted a few risks. The average growth rates are not that high, historically speaking, making the continuing recovery vulnerable to shocks. “You only need a handful of accidents to see growth rates come down potentially quite meaningfully,” he said.
A sudden panic among investors and a sharp selloff – unlikely, according to Budden – would cause a dramatic loss of confidence in markets such as the US, where financial flows strongly affect the economy.
Political risk, for instance around Brexit or the Trump administration’s unclear stance on international trade, also needs to be considered even though “none of these things would necessarily be our central scenario”, Budden noted.
