Amato on the Late-Cycle Dilemma

Amato on the Late-Cycle Dilemma

Joseph V. Amato, president of Neuberger Berman Group LLC and Chief Investment Officer – Equities at Neuberger Berman, has written a thoughtful discussion of late about where the markets, and the business cycle, stands.

This, the end of 2017, is a “late cycle” moment. Equities continue to rise, but the leadership group that accounts for that rise is narrowing. The FANG stocks (a term popularized by Jim Cramer) have been key. FANG stands for: Facebook, Amazon, Netflix, and Google. (Google is now listed as Alphabet Inc., but “FANA” is not so impressive an acronym, so this one will stick.)

All four FANG stocks are on NASDAQ. As Amato points out, NASDAQ is up 25% in 2017 YTD while the Russell 2000 Value Index is barely up at all. Such narrowness of bullish sentiment is itself historically a bearish sign. It indicates, as Amato says, “that investors are chasing winners rather than being comfortable investing in more broad-based growth – a phenomenon typical of late cycle behavior.”

In September the smaller companies and cyclicals started catching up with the large-cap high-tech firms, and so far as it went that was reassuring. But, Amato notes, that seems already to have fizzled out.

Hopes and Worries

Another possible sign of hope has been movement toward tax reform on Capitol Hill. The reforms under consideration would help small business. Such a helping hand might extend somewhat the economic expansion. But on the other hand it might never materialize, because the House and Senate Republicans may end up dug into their positions on significantly different versions of reform.

Meanwhile, in the fixed income world, Amato continued, “we see very tight credit spreads and covenants that are weakening or disappearing altogether as investors chase yield and ignore certain risks.”   In Treasury markets specifically, yield curves are flattening, and that historically, has also (like the narrowness of equity leadership) been a sign of challenging times ahead.

What about the Federal Reserve? President Trump, on November 2, nominated Jerome Powell, a member of the Board of Governors of the Fed since 2012, to become its next Chair this coming February, when Janet Yellen’s term ends.  Amato is concerned that Powell’s “lack of articulated economic views makes it very difficult to judge how he will respond to the inevitable economic downturn.” The shift in the Chair, as well as the coming retirement of William C. Dudley, president of the Federal Reserve Bank of New York, who has been a very influential supporter of Yellen’s policy in recent years,  make this feel like a turning point for Fed policy. That is a worry for the markets: turning toward what?

All of this sets up the dilemma that is worrying thoughtful market participants just now, Amato explains. Sentiment is still bullish. There is money to be made still riding upward momentum.

But: should investors be looking to make that money? Or should they be moving their assets so as to hedge against the turn when it comes? This is always a choice that has to be made in late markets, among those who recognize the lateness but who do not know (because one can never know) just how late it is. Does one risk bailing out too soon and miss remaining opportunities? Or does one continue to play “sell to the bigger fool” valuations, and risk being the biggest fool at the end of the chain?

Going Beyond Amato

Building on Amato’s line of thought, one might add that markets need not worry about a prolonged confirmation fight over Powell. He is a compromise pick who will very likely appeal (well enough) to both Republicans and Democrats, even though inspiring little enthusiasm among members of either party.

Powell is a Republican himself, and in a speech in early October he said, “More regulation is not the best answer to every problem.”  The Federal Reserve has banking-regulatory functions, and his Republican supporters (including the President) may well expect that Powell’s deregulatory sentiments will have practical implications during his chairmanship.

Meanwhile his Democratic supporters may well have their eye on the ball of monetary policy strictly considered. They believe Yellen’s policy (accommodative on the money supply, very gradualist on interest rate hikes) has been the right one and they believe, with some reason, that Powell will continue it.

That may all be reasonably clear, but it leaves us with the sense that we are far into a bull run that won’t last forever, and that the late-cycle dilemma is real.




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