Delaying the inevitable: How long can central banks extend the credit cycle?
Calling the end of the current credit cycle is becoming an increasingly popular sport among seasoned market-watchers. While there is division over exactly when it will conclude, the consensus is it will be soon.
Last week, Deutsche Bank analysts came to the conclusion that they were “not quite ready to call the end of the spread cycle yet” – but added that 2017 looked more likely to see the turn towards recession again.
A typical credit cycle moves in three phases: recession, recovery and expansion. Global markets have been in the third phase since 2012. With many banks in particular still restructuring their balance sheets from the last credit crisis, extending the expansion would be in many lenders’ interest.
This phase has already been lengthened by major central banks taking longer than expected to normalise policy. Many are hoping that the trillions of dollars pumped into the financial system by these central banks, and the fact that they are now buying credit, will make the inevitable downturn slower.
While the number of businesses defaulting on loans is picking up – a classic warning sign that the cycle is about to turn – the rise has be dismissed by some as mainly concentrated among players in the oil and gas and mining industries, which of course have been damaged by the low price of oil and other commodities.
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Recent policy by the European Central Bank seems to be aimed at boosting credit as opposed to weakening the euro, which could stave off the end of the cycle for a little longer. However, central banks’ actions are gradually having less and less direct impact on equities – which “might mean their influence is waning and the cycle is becoming more vulnerable”, the Deutsche analysts point out.
But the signs that we’re getting to the latter stages of the cycle are growing.
Companies’ action on dividends seems particularly to typify a late cycle. S&P 500 dividends for the third quarter of 2016 should set a new record high, and could be the first quarterly $100bn S&P 500 dividend payout, according to research by Sam Stovall, US equity strategist at S&P Global Market Intelligence.
Volatility, which historically moves higher towards the end of a bull run, has been rising this year, with noticeably more days where the S&P 500 moves by more than 1 per cent compared to last year.
There are also a couple of events which could derail these predictions. The Italian constitutional reform referendum and the US election both offer the potential for nasty surprises – in the case of the US presidential election, what some are unkindly dubbing the “orange swan” of Donald Trump in the White House.