Macro and Australian equity strategist, Macro Strategy Advisors

Shane Lee

Macro and Australian equity strategist

Macro Strategy Advisors

Cross Asset Strategy

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The US yield curve has flattened sharply since our 2019 outlook was released lifting the risk that the end of the business cycle is rapidly approaching. However, a large part of this flattening seems to be due to a short squeeze in the 10-year futures contract.  Positioning in the 2-year futures contract remains short and could also be squeezed if this week Fed guidance signals its tightening campaign is done for now.  This could steepen the curve and keep the business cycle alive.</li>
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Other indicators of the business cycle such as credit spreads, the 2-year yield, the Fed’s Loan Officer’s Survey and the Philly Fed survey all suggest the cycle still has some way to go. The New York Fed survey is the exception, with it indicating a recession is on the horizon. </li>
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In our 2019 outlook, we lifted the bar further on defence. We shifted overweight Property and added to our overweight in Healthcare, but we also added our exposure to the Tech sector by including TNE.  We have become more agnostic on Growth performance as an investment style vs Value, preferring stocks with earnings that are more defendable in the face of an interest-rate-led global slowdown regardless of Valuation. </li>
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One macro scenario that could evolve next year is that US productivity growth lifts. This would be positive for risk assets and extend out the business cycle.  US margins are close to record highs and stronger productivity growth would protect them in the face of rising late-cycle cost pressures or further tariff increases.  In this scenario, inflation would remain contained and Fed could sit on the sidelines for most of the year.  However, stronger productivity growth means the neutral rate was also higher and this could bring the Fed back into play, but with robust margin performance.  The relationship between business investment and labour productivity growth suggests we should have some optimism on the productivity outlook.</li>
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An extension to the cycle could be positive for Australia. The market will have probably factored in the worst possible earnings scenario for the Banks following the Final Report from the Banking Royal Commission and Resources could have another relatively good year on the back of stronger global growth.  Moreover, valuations in these two key sectors are supportive.  Stocks with US operations and particularly those with housing exposures such as JHX and BLD are a no-go zone for us.  Similarly, BXB, PGH and AMC are stocks to avoid until there is some resolution about the productivity outlook in the US.</li>
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The US yield curve has flattened sharply since our 2019 outlook was released lifting the risk that the end of the business cycle is rapidly approaching. However, a large part of this flattening seems to be due to a short squeeze in the 10-year futures contract.  Positioning in the 2-year futures contract remains short and could also be squeezed if this week Fed guidance signals its tightening campaign is done for now.  This could steepen the curve and keep the business cycle alive.

Other indicators of the business cycle such as credit spreads, the 2-year yield, the Fed’s Loan Officer’s Survey and the Philly Fed survey all suggest the cycle still has some way to go. The New York Fed survey is the exception, with it indicating a recession is on the horizon. 

In our 2019 outlook, we lifted the bar further on defence. We shifted overweight Property and added to our overweight in Healthcare, but we also added our exposure to the Tech sector by including TNE.  We have become more agnostic on Growth performance as an investment style vs Value, preferring stocks with earnings that are more defendable in the face of an interest-rate-led global slowdown regardless of Valuation. 

One macro scenario that could evolve next year is that US productivity growth lifts. This would be positive for risk assets and extend out the business cycle.  US margins are close to record highs and stronger productivity growth would protect them in the face of rising late-cycle cost pressures or further tariff increases.  In this scenario, inflation would remain contained and Fed could sit on the sidelines for most of the year.  However, stronger productivity growth means the neutral rate was also higher and this could bring the Fed back into play, but with robust margin performance.  The relationship between business investment and labour productivity growth suggests we should have some optimism on the productivity outlook.

An extension to the cycle could be positive for Australia. The market will have probably factored in the worst possible earnings scenario for the Banks following the Final Report from the Banking Royal Commission and Resources could have another relatively good year on the back of stronger global growth.  Moreover, valuations in these two key sectors are supportive.  Stocks with US operations and particularly those with housing exposures such as JHX and BLD are a no-go zone for us.  Similarly, BXB, PGH and AMC are stocks to avoid until there is some resolution about the productivity outlook in the US.


A Houdini Act Worth Considering: Implications of a Pick up in US Productivity