How long can the global rally in financial markets last?

THE risk-on mode has been turned on amidst the global rally in financial markets; the question is how long can the party last?

Are we in for another wave upwards, or as some say “an early upswing,” or a countdown before the “last waltz”?

“Following the financial crisis, it was balance sheet expansion by major central banks that flooded the world with money and juiced the markets.

“With the US Fed starting to shrink its balance sheet, the countdown to the end of the band’s hour on stage has begun,’’ said Pong Teng Siew, head of research at Inter-Pacific securities. (The Fed has started to reduce its US$4.2 trillion in holdings of US Treasury bonds and mortgage-backed securities that it purchased to stimulate the economy following the financial crisis).

Wall Street analysts have cut their estimates for S&P 500 income growth by more than half. At 3.6%, they’re now predicting the biggest slowdown since 2011 after profits expanded about 11% in the March-June quarter, said Bloomberg.

But investors are banking on the prospects of tax cuts in the US and a global economic recovery that may help prolong the profit cycle.

“We are in an early upswing phase with healthy recovery, low rates, low inflation and increased spending.

“Depending on global developments, we will enter the late upswing phase when most people are in the boom mindset with easy money, high inflation, rising rates and restrictive government policies,’’ said Danny Wong, CEO at Areca Capital.

Asian markets are not expensive. “MSCI Asia ex-Japan is trading at 14 times price-to-earnings ratio. If companies can deliver earnings, markets will continue to perform.

“Certain stocks in cyclical industries might face headwinds on rich valuations,’’ said Thomas Yong, CEO at Fortress Capital.

“The animal spirit in financial markets has revived, but they must be cautious of the unexpected. The uptrend in global interest rates is gradual now. Even if the pace accelerates slightly, the knee-jerk reaction can cause huge losses,’’ said Nor Zahidi Alias, chief economist at Malaysian Rating Corp.

“The risk of policy uncertainty remains as we move into 2018. The great unwinding of the Fed balance sheet may lead to periods of volatility as liquidity is drawn from financial markets.

“A faster-than-expected increase in rates could tighten financial conditions and trigger reversals of capital flows to emerging economies.

“Along with US dollar appreciation, this could strain emerging economies with large debts denominated in US dollars or those with mismatches in balance sheets,’’ said Lee Heng Guie, executive director at Socio Economic Research Centre.

Other major central banks have not begun to shrink their balance sheets yet.

“Until they do so, perhaps late next year, capital will still flow into the US, and so, the dance goes on,’’ said Pong, recalling the words of former Citigroup chief executive Chuck Prince that “as long as the music is still playing, you’ve got to get up and dance.”

Some large funds consider US dollar strength to be unsustainable.

“Credit markets have re-rated Malaysia upwards but further inflows were limited. The ringgit is at about its real effective exchange rate, and I do not see more upside potential at this moment,’’ said Pong.

Some view the ringgit may outperform. “The trade weighted index (TWI) remains weak, and we are seeing strong export performance from recovering crude oil, palm oil and manufacturing.

“Expect the ringgit to hit RM4.10 to the US dollar in due course,’’ said Hor Kwok Wai, chief operating officer, global markets, at Hong Leong Bank.

The TWI shows the relative strength of the ringgit against a basket of currencies which is weighted by the size of their trading activities with Malaysia.

“Although the ringgit has strengthened in the past few months, it is still relatively weak compared historically on the TWI,’’ said Hor, adding that the index can improve with the ringgit strengthening against the currencies of its trading partners.

“The ringgit’s rally is supported by a good set of growth numbers in the first half. As long as external trade remains vibrant and the economy is inundated by capital flows into bonds and equities, the prospects for the ringgit will remain positive,’’ said Zahidi.

“The US dollar has performed poorly year to date, due to delays in policy reforms and a less hawkish tone by the Fed. The outlook for US dollar hinges mainly on the path for rate hikes,’’ said Yong.

“Forces that influence the movement of the ringgit include the timing and magnitude of the Fed’s monetary agenda, policy shocks, uncertainties associated with the Trump administration and Brexit talks and geopolitical tensions.

“Domestically, economic growth prospects and future direction of interest rates also play a part,’’ said Lee.

Columnist Yap Leng Kuen is cautious of never ending parties.