During the past two months, the behaviour of markets and commentators could be labelled as schizophrenic.
Investors have become concerned about poor communication from certain central banks, which have not covered themselves in glory. Their behaviour has planted the seed of doubt, and they have gone from being seen as omnipotent to unable to provide necessary clarity to the market.
Performance of indices in 2015
Source: FE Analytics
The latest change in Fed language confirms the uncertain direction of travel: any references to global, international and overseas developments (reported as a concern in late September) have miraculously disappeared from the Fed’s October statement. What a difference a month makes!
This uncertainty has also manifested itself elsewhere. As wryly noted by well-known strategist Ed Yardeni, a recent article in Business Insider arguing that “It’s time to start talking about a US recession” was followed a week later with “Six signs the US economy is nowhere near recession”.
From recession being “now here” to “nowhere” is quite a change of position. So, what is wrong with the US economy? In our view, not much.
A few decades ago, when I started managing high yield corporate investment portfolios, the mantra in the markets was 1.5 per cent. If US real growth slowed to that level, we expected the value of our investments to go down rapidly, as defaults would increase exponentially.
The same concept, illustrated in an intellectually more elegant way, was even discussed by the Fed (by Dennis Lockhart in a speech and by Jeremy Nalewaik in a white paper, both in 2011).
As an aeroplane which reduces its speed will eventually stall and come down, the US economy would go into tailspin if economic growth were to decelerate below 2 per cent. 
Although economies go in cycles, and it is in the natural order of things that an economy will go into recession from time to time, we do not think this is currently the situation for the US.
We have several times noted certain positive factors (consumption, services, lending) which have been supportive of the US economy. However, three items in particular have hit the economy and earnings in the last 12 months.
These were the rising value of the US dollar (which led to turmoil in emerging economies and also took its toll on corporate earnings), the collapse in the price of oil and a generalised tightening in financial conditions.
As these problems seem to be waning, we anticipate a better tone for growth and an earnings per share recovery in the first half of 2016. Perhaps only back to mediocrity, but enough to avoid any dip below the “stall speed” of 2 per cent.
Economy and market bears would not agree with us, pointing to two major issues.
First, they would note a collapse in manufacturing and global trade. In recent decades, we have looked at the world economy primarily through the lens of global trade, manufacturing and investment.
If we were to persist in this approach, we would be disappointed. As we get older, our eyesight prescription usually changes and we need to adopt different lenses. Today, the nature of economic growth has changed too, and we need to look at it differently.
Domestic activity, the service sector and consumption are increasingly important. These are all growing and will probably lead the economy in the coming quarters.
Secondly, bears would state that the benefits of monetary policies based on quantitative easing are declining and will not work going forward. It is true that quantitative easing cannot be the only answer to lower-than-hoped economic growth.
Fiscal policies will continue to have a role, in both the short and long run.
The good news is that apparently a bipartisan accord has been struck on the US debt ceiling, with a mild expansionary effect and positive consequences for the next 18 months.
Longer term, the world needs a creative fiscal plan. Why not make multilateral organisations such as the International Bank for Reconstruction and Development, the European Investment Bank, the Asian Development Bank and Asian Infrastructure Investment Bank borrow cheap money in the form of large, long-term bond issuance, say over 50 years, at interest rates between 1.5 per cent and 3 per cent?
The proceeds could then be deployed into fast-track projects, of a kind which would immediately stimulate demand and unleash benefits to growth. If properly structured, the accrued benefits to growth and taxation would exceed the borrowing costs.
In the meanwhile, away from the US, monetary policy will keep on helping us, at the margin. The European Central Bank seems to have come to the rescue, the Bank of Japan will be ready to support the economy and the People’s Bank of China is ready to embark on a substantial series of cuts to official rates and to the Reserve Requirement Ratio (RRR).
Such policies will help the economy, corporate profitability and market prices for a while.
For now, our stance on markets since the crisis of the 24th of August has been right, and we continue to see the glass as half full.
Performance of indices since ‘Black Monday’
Source: FE Analytics
We expect that, in this ongoing struggle between bulls and bears, we will gradually transition to a regime of higher volatility which will test investors’ conviction and require a very disciplined approach to investing.
As usual, earnings growth and valuations will determine the path for markets in 2016. While certain equity markets are priced for perfection, others still offer a good upside.
As such, Baring Multi Asset Group has upgraded equities to “preferred”. UK equities and energy have also been upgraded from “not preferred” to “neutral” while industrial equities have been downgraded one notch to “not preferred”. European equities remain unchanged at “strongly preferred”, as is property.
Will we experience a recession? At some stage in the future, surely … but not now.
Marino Valensise is head of Barings’ Multi Asset. All the views expressed above are his own and should not be taken as investment advice.
