Guy Monson on several causes for good cheer in the global markets — though admittedly rather more so for Western economies than for emerging ones
FOR THOSE ACCUSTOMED to bankers enlarging the financial effects of world events through the likes of leverage and derivatives, this year has been oddly and surprisingly reassuring. 2011 has seen natural disasters, aggressive political change and commodity price surges which would usually have spelled disaster for global markets. Few investors would have guessed that — in the face of regime upheaval throughout the Arab world, Nato’s entry into Libya, $120 oil and an earthquake/nuclear crisis in Japan (as well as continued European bailouts) — most Western indices would in fact rise.
Local investors in the Dow Jones Industrial saw close to double-digit returns (year to date), the 50 biggest companies in the eurozone are up by nearly 5 per cent, the FTSE100 has just broken even, and the Nikkei 225 is down by only a little more than 5 per cent. Intriguingly, the best returns are from the old economies, rather than the new, and (generally speaking) the larger the company, the more impressive its equity performance. Volatility has remained unusually low, while UK and US bond markets (despite deficits) are almost unaltered for 2011.
But what has caused such a sudden character shift in financial markets, and can this attitude survive any more natural disasters or geopolitical surprise events? Naturally, huge central bank liquidity via near zero interest rates mixed with QE continues to pacify, just as Ben Bernanke had always hoped. Of course, the US bond purchase programme is coming to an end, but the Federal Reserve has restated that current super-low rates will stay put for an ‘extended period’.
The European Central Bank, conversely, began raising rates last month, but President Trichet was already sounding markedly less hawkish than market expectations by early May, and did not confirm further rate rises for June (these are more likely to occur in July). Meanwhile, slightly weaker UK business surveys quickly undid talk of an early rate rise from the Bank of England, despite the latter perceiving a ‘significant risk’ of inflation moving above 5 per cent in the months ahead.
Elsewhere, inflationary pressures in the emerging world are increasingly hard to ignore, not least due to the political consequences of towering food and energy prices across the Arab countries. Timorous steps earlier in the year to limit bank reserves or bring foreign inflows to a standstill (in fear of currency appreciation, especially against China) are being cast off. India, Colombia and Russia have all hiked interest rates, while China, Poland and Brazil have allowed more speedy currency appreciation than would have formerly been accepted.
The Chinese yuan recently fell to under 6.5 per dollar, ie appreciating by more than 5 per cent since China loosened its currency peg with the US dollar in June 2010. The mercantilist unwillingness to embrace more conventional monetary-policy tools is giving way to recognition that currency appreciation, particularly for commodity-hungry developing economies, is a remarkably effective way of lowering inflation.
So far in 2011, emerging world markets are considerably underperforming those in the West, which may curiously form part of the foundations of Western market stability. This indicates the start of a broad rebalancing of growth from East to West, as since the credit crunch the emerging markets have been the sole engines of growth.
Should a slowdown bring a reverse in the enormously harmful spike in oil and commodity prices, the medium-term effect on global growth and margins will be positive, and the pointed price surge in imported goods which currently distorts our own inflationary picture will be reversed. The big energy, commodity and industrial companies will be affected, but that leaves room for a re-rating of global food, healthcare and consumer stocks which now have the intellectual property, pricing power and brands to suit a new, discerning Asian middle class.
Above all, however, it is the superiority of ‘blue-chip’ equities which is underpinning today’s stability, following a decade or more of disappointing and volatile returns. In the S&P 500, cash as a percentage of total assets is at its highest in more than 30 years, while the wider European market’s cash level is close to a twenty-year high. In the UK, businesses have the lowest net-debt-to-earnings in more than eleven years, a figure set to fall further in 2012.
My view is that this startling financial market resilience will persist for as long as edgy central bankers in the West permit their inflation-fearing counterparts in the East to lead the pack in terms of policy tightening. The investments of choice then become blue-chip ‘thematic’ equities, presenting diversified global earnings, extraordinary dividend growth and exceptional cash generation, at a time when there is small competition from near zero cash and real bond yields. Add in possibly another round of QE in Japan, more trophy M&A, and a steady thawing of the bond mountain, and this could be just the start of a multi-year flow of funds into a somewhat more ‘genteel’ global equity market.