Equity markets are no longer cheap, but they are also not expensive

In this week’s bulletin:

  • Markets are dipping amid profit-taking and anticipation of US central bank policy.
  • The five years since the Federal Reserve cut interest rates have been a positive environment for most asset classes.
  • Equity markets are no longer cheap, but they are also not expensive.
  • The Bank of England said the economy needs to strengthen significantly before it raises interest rates.


Stocks stutter

The difficult end to 2013 continues for global equity markets. Stocks fell 1.6% on Wall Street, which experienced its worst week since August ahead of the upcoming Federal Reserve meeting that should prove crucial to clarifying the future of quantitative easing in the US. Elsewhere around the world, Asian equities fell once again to reach a three-month low and major European markets fell around 2%. Emerging markets continue to suffer as the prospect of reduced Federal Reserve action overshadows the region. Closer to home, the FTSE 100 index closed the week down 1.7% to 6,440 to record its sixth consecutive weekly decline.

Monday 16 December 2013

The declines occurred despite a midweek Congressional budget agreement that led investors to conclude that months of political friction in the US was finally easing – a problem that has acted as a significant headwind to the country’s economic recovery. Whether recent declines are due to profit-taking by those who have made strong gains in 2013, or a sign of increasing fear that the US central bank is preparing to reduce its asset-buying programme, markets are presently wobbling towards the end of the year.

Data released over recent weeks, including news that November retail sales increased by 0.7%, have added to the belief that the US economy is improving to the extent that the Federal Reserve could consider tapering sooner rather than later. US Treasury yields fell on news of a drop in inflation; while German 10-year debt yields also fell to 1.83% despite the eurozone showing a current account surplus and the European Central Bank’s shrinking balance sheet. The euro is now at its highest level against the dollar since November 2011. Unsurprisingly in an uncertain week, gold was more stable and climbed to $1,234 per ounce.

In contrast to the situation in the US, many economists believe that the Bank of Japan may need to increase its own stimulus measures to stand a chance of hitting its 2% inflation target. This has been pressuring the yen, forcing the currency down to its weakest level in five years and significantly benefiting the export-heavy Nikkei 225.


Happy anniversary

This week marks the fifth anniversary of the Federal Reserve’s decision to cut interest rates and start asset purchases. In the period since, it is clear to see that taking more risk has been firmly rewarded. Deutsche Bank recently wrote in a note that this had been a marvellous environment for virtually all asset classes, despite this being one of the weakest economic recoveries on record. Since December 2008, an investor could have doubled his or her money in emerging market and US equities, as well as in European high-yield debt and several metals, such as copper. Of course, given investor sentiment in late 2008, very few were rushing to buy risk assets at that time.

By providing a comfort blanket to markets, central bank action helped to contain the crisis that effectively peaked in March 2009 when the S&P 500 dropped to 666. Official interest rates of near zero also persuaded bond investors to move into ‘riskier’ areas than government debt, which had been so popular in 2007 and 2008. At that point, the high-yield bond market had priced in widespread bankruptcies which never materialised to the extent anticipated.

The end of the year often sees investors take stock and review their portfolios. Recent years have seen strong returns from a range of assets, raising understandable questions over sustainability, particularly in the light of uncertainty over the Federal Reserve’s next steps.

Monetary policy around the world will remain supportive. Economic growth is going in the right direction, but the margins are fine. No one knows what will be the best-performing asset class over the short term. Tips for 2014, from various industry experts, include investing in developed market equities, emerging equities, Southern European assets, the UK, and Japan; or just buying any asset denominated in dollars.

Investing in one asset increases the risk in any portfolio, offering an all-or-nothing option, which if wrong leaves the investor underwater. It is also difficult to envisage that equity market returns will continue at 20+% per year. That said, whilst equity markets are no longer cheap around the world, they are not expensive either, and still appear to offer better value than cash and some bond markets. Put simply, diversification of asset classes and a long-term investment horizon is the key to successful investing.



Latest signals from the Bank of England suggest that it will not raise interest rates until Britain has enjoyed a prolonged period of strong economic growth, resulting in higher incomes and lower unemployment. In a recent speech, Spencer Dale, the Bank’s chief economist, attempted to provide reassurance to business leaders that the economy would have to be far more robust before the Monetary Policy Committee (MPC) raises rates.

In August, Mark Carney provided ‘forward guidance’, stating that unemployment would need to fall to 7% before the Bank would start to think about a rate rise. Last week, Mr Dale provided further clarity on the position being adopted by the Bank. With the average wage rise failing to beat inflation for five successive years, consumers will not be spending the required amounts of money to sustain the economic recovery, regardless of the unemployment rate. Economists now believe that the 7% level is simply a checkpoint to review rather than a trigger for action, and every speech made by a member of the MPC makes it clearer that a rate rise is some way in the distance.

Within his speech, Mr Dale also gave valuable insight into his view of the housing market. He warned the public not to be naïve over the future, citing Britain’s economic history as evidence that the housing market is akin to a microwave – with the ability to go from “lukewarm to scalding hot in a matter of economic seconds”. However, he tried to allay fears of a bubble by emphasising that the Financial Policy Committee is far better equipped to response to any crisis than in the past, pledging that lessons had been learned.

Mortgages of more than 90% loan to value are becoming more commonplace, and several institutions are happy to consider 100% once again, just six years after their popularity was at the peak. The full extent of Britain’s reliance on credit will be revealed this week, as figures are expected to show mortgages, personal loans and lending to small businesses, as of June 2013, total more than a trillion pounds.

The data compiled by the Council of Mortgage Lenders will be broken down by postcode for the first time, giving an accurate picture of where the levels of indebtedness are highest in the UK. Not everyone is happy that this information will be broken down in this way. Senior banking sources are concerned it will be used to criticise the banks for not supporting small businesses in various areas of the country. The City is also concerned that it may lead to further regulation to force lending to regions currently ignored, similar to the Community Reinvestment Act in the US.

Mark Carney will this week appear in front of the Economic Affairs Committee for the first time, to answer questions on the general state of the UK economy and the potential conflict between his own Monetary Policy Committee and the Treasury over the future of the housing market. He is also expected to face questions on Scotland’s use of sterling should the country become independent.


Bumper week of data

Economic figures to be released in the UK this week include those for growth, unemployment and, as previously mentioned, borrowing; but most attention will be paid to November’s inflation report. Expectations are that the much-publicised spate of energy price rises will take their toll, pushing the Consumer Prices Index up to 2.3% and the Retail Prices Index up to 2.7%, following the moves by the ‘Big Six’ energy companies. Despite food price rises slowing, the sheer size of the energy increases are expected to far outweigh that fall. It is also thought that additional tariffs will be applied to energy bills in early 2014 after changes by the regulator, Ofgem.

Economists believe that the third-quarter GDP figure will be revised upwards from 0.8% on the back of encouraging construction data since the initial estimate. Employment data to be released on Wednesday are expected to show unemployment holding steady at 7.6%, with wage growth remaining subdued.

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