BACK in March this year, global equity markets looked into the abyss as the FTSE100 plummeted to about 3,500, which was 50% lower than its peak in December 1999.
Even the most optimistic investors were struggling to see any signs of a recovery and instead we were facing the potential end of the financial system as we knew it with the banks especially peering over the edge of the precipice. Investors were worried that the financial crisis would push global economies into their deepest slump since the Great Depression of the 1930s.
The savagery of the downturn was mirrored by a general gloom about the prospects for all financial assets. Low share prices fed investors’ pessimism about the economy, which in turn pushed prices lower.
This kind of uniform anxiety, however, is very often a signal that markets are at a turning point. The point at which investors believe that stocks can only head lower is very often the point at which they start to head higher. It is a persistent feature of bull and bear market cycles that the point of maximum despondency is also the point of maximum financial opportunity.
Out of the wreckage
Sure enough, out of the wreckage of investor sentiment in Marchanew launch-pad for the market was constructed. Since then the MSCI World index has risen by 55%. If it is no more than a bear market rally, as some have suggested, then it is one that few investors will have wanted to sit out.
After a pause for breath in May and June, when investors questioned the sustainability of the rapid market rally in late March and April, shares resumed their upward path in July with the FTSE All Share Index rising by an impressive 8.4% during the month.
At the time of writing, markets in Europe, the UK and America are now all in positive territory for the year while Asian markets have continued to outperform as investors’ appetite for risk has increased.
The banks, having been saved through a combination of government guarantees, taxpayer-funded capital injections and in the most extreme cases outright nationalisation, look to have been stabilised, giving the global economy at least one necessary, if not sufficient, condition for a recovery.
For the first time in a very long while, investors must now start to ask themselves whether the new mood of enthusiasm is justified by events. Examples of the new bullishness include a recent poll of investors by Reuters which showed that equity holdings are back up to levels last seen in the weeks running up to the collapse of Lehman Brothers. Reuters says cash holdings are at the lowest level since May 2007.
It may not feel like recovery yet but many economic releases are published with a time lag and it is usually not for many months after the event that a major peak or trough in economic activity becomes a widely accepted fact, by which time equity prices have already moved.
There are good reasons for improved sentiment. The first of these is the unexpected strength of corporate earnings in the second quarter of 2009. In the US, around three quarters of the companies that have announced results so far have beaten expectations, with only 14% missing estimates.
In Europe, the out-performance is less marked but more than half of companies are beating forecasts. The Organisation for Economic Cooperation and Development’s (OECD) lead indicators have troughed, business confidence is turning upwards and GDP forecasts are edging higher.
A clear indication of the improvement in sentiment was provided recently when the Chinese stock market, which has soared in value since the end of last year, fell by 5% on fears that Chinese banks might start restricting loans to cool enthusiasm for shares and property.
Remain relaxed
When Shanghai has dropped like this in the past, there has often been a knockon impact in markets around the world. This time, however, investors largely shrugged off the news.
Another reason for investors to remain relaxed about the equity class as a whole is that shares are, by historical standards, not expensively valued. The price-earnings ratio of the MSCI World Index, which measures how expensive shares are compared to company profits, has risen sharply since March to levels last seen in 2007. However, even after this rise the ratio remains lower than at any point since the early 1990s.
Financial markets remain volatile, with the forthcoming US earnings season the key factor determining the short-term outlook for stock markets. Looking further ahead, most commentators warn of continued financial market volatility well into 2010, despite the modest economic recovery which will begin in the second half of the year.
The key triggers, therefore, to monitor in this latter part of the year will be consumer spending in the OECD economies and the availability of credit. There are positive drivers, such as tax changes and auto purchase schemes, and negative headwinds including higher unemployment, adverse wealth effects, and energy costs.
The recovery in manufacturing and trade will fizzle out if retail spending falls back. Changes in the savings ratio, up from zero in 2007 to 6% currently in the US, will be key.
The question is whether households retrench further – some estimates of the relationship between savings and wealth suggest the ratio should continue to rise to about 10% – or whether consumer confidence improves, allowing them to look through the downtrend to better times ahead.
Many experts expect stronger economic growth in many global emerging market (GEM) economies than their OECD counterparts. They have resisted the worst effects of the global recession due to a rapid policy response, e.g. China, and a less vulnerable financial system, e.g. Latin America. Nevertheless, the growth gap could start to slow in coming months, partly as OECD economies recover but also due to policy decisions in GEM economies.
Much of the growth we are seeing has been spurred on by an exceptional fiscal and monetary policy stimulus which surely can’t go on indefinitely, whilst some commentators continue to warn that the global economic recovery into 2010 will be muted by historical standards, and below consensus.
The housing markets in the US and the UK are not likely to stabilise before 2010, as the supply of new homes is brought back into line with lower levels of demand and as foreclosures ease.
A key trigger to monitor continues to be mortgage rates, especially in the US but also Europe and the UK. Lower US mortgage rates are required for refinancing activity to pick up again. An upturn in the investment cycle looks some way away bearing in mind the excess capacity in the OECD economies.
Data from the UK, however, show that investors have regained their appetite for risk. The Investment Management Association’s monthly data for June show the two best-selling fund sectors for retail investors were Asia Pacific, excluding Japan and Global Emerging Markets. They took £300 million together, compared with just £77 million for the usual favourite, UK All Companies.
What is clear from all the data is that remaining invested is still the key to long-term investment performance; trying to time when to actually encash or invest is likely to lead to an investor missing out on the best days – as mentioned earlier, you would not have wanted to be out of the markets in July!
Finally, diversifying your investments across equities, bonds/fixed interest and cash, as well as across a number of world markets, can help lower your overall level of investment risk and make for a smoother investment ride through these troubled times.
■ The author can be contacted at AB Wealth Ltd, Almswood House, 93 High Street, Evesham, Worcs. WR11 4DU; telephone 01386 442597, e-mail andrew.neale@abwealth.co.ltd.
