In this week’s bulletin:
- Despite a slow US recovery, Wall Street is upbeat for equities
- US corporates are displaying confidence, particularly in the telecoms sector
- Wall Street and Main Street are waiting for a Fed decision this week on QE
- Five years after the Lehman Brothers collapse, patient US equity investors have reaped rewards
After Lehman: midway upon the journey
Five years after the collapse of Lehman Brothers, the largest bankruptcy in corporate history is rightly viewed as a dark cloud through which a wider world has come to judge global finance and its progress in adding to or subtracting from our mutual and individual wealth. There is no need for another tour here of the ghosts of financial crises past, let alone present or yet to come, but it is fair to say in passing that America, five mid-Septembers on from the loss – without bailout or rescue – of the once-mighty Wall Street investment bank, finds itself in the midst of another brooding change of season (even if Atlantic hurricanes have this year held off from its eastern seaboard).
In Washington, the Federal Open Market Committee gathers over the coming days to decide on whether or not to begin the end of its quantitative easing (QE) programme, and also potentially to choose a replacement for the US Federal Reserve chairman Ben Bernanke. Monetary hawk and former US Treasury secretary Larry Summers’ withdrawal of his candidacy at the start of the week has raised the prospect of a more dovish choice, such as Janet Yellen, to trim the Fed’s stimulus package and raise rates at a slower pace. In the White House, the President and his minions are counting on a positive response from Damascus to the US–Russian deal to destroy its chemical weapons; while on Capitol Hill members of Congress will have one eye on Syria and another on the $16.7 trillion US debt ceiling which needs to be raised next month. In New York, and other financial centres, markets are waiting for and anticipating these developments in US financial and foreign policy.
There are certainly concerns swirling on both sides of the Atlantic around asset values, from equities to property, as well as the robustness of the financial system at this moment of collective reflection on the 2008 financial crisis. There are those who worry that economic growth in the US and Europe remains listless. However, from the perspective of Wall Street and specifically US investors, the horizon looks rosy, with those who retained their faith in equities in the intervening years reaping handsome returns.
The S&P 500 index on Friday closed at 1,688 points compared with the 1,193 level reached when markets opened on 15 September 2008 to the news that Lehman had filed for bankruptcy protections. Last week the S&P 500 index gained 2% amid flat economic data and a strong performance across sectors, including a 3% gain for telecoms. US ten-year Treasuries yields fell 2 basis points on Friday to 2.89%. Across the Atlantic, the FTSE 100 ended the week up 0.6% at 6,584; the FTSEurofirst 300 index was up 1.7% to 1,250. In Tokyo, the Nikkei 225 Stock Average gained 3.9% over the period on growing corporate and economic confidence.
What is defining America’s corporate news in recent weeks is a renewed buzz of activity, particularly in the telecoms and technology sectors. Verizon last week issued $49 billion in bonds which broke the record for a sale of corporate debt. The American telecoms group will use the funds towards its $130 billion buy-out of Vodafone’s stake in their joint US mobile phone business Verizon Wireless. Institutional investors flocked to the Verizon bond sale, attracted by the competitively high yield. US technology leviathan Microsoft swallowed the once-mighty Finnish mobile group Nokia earlier this month for a minnow’s fee of $5.4 billion. Apple brought out two new iPhones with an eye on China. Twitter announced in 135 characters its planned initial public offering in New York for up to $20 billion. The US social media group is hailed by some as the Marconi and the telegram of our age, with all the investment resonance of that historical comparison, and by others as an overhyped fad.
But all paths this week for Wall Street and Main Street lead to Bernanke’s decision on Wednesday on the future of QE and how the Fed wishes to time the markets and the economy away from its support. The markets have largely priced in the tapering debate and triggered a retreat of easy money from emerging markets since Bernanke hinted in May that he would wind down the QE programme. Markets and investors looking to journey further from the loss of Lehman and the financial crisis will want now to know the amount of tapering, rather than ifs and whens.
Back to the future?
The Lehman anniversary was bound to trigger rumination on the distance made from the events of 2008. Some have raised concerns over market valuations and made comparisons with the summer of 1987, prior to Black Monday that October, when there was also a shift from savings to consumption amid a tightening money supply. Others point to emerging market upheaval, rising interest rates and Middle East problems. But, on Wall Street, there is a solid body of upbeat opinion that US equities are on the march.
US investment bank Goldman Sachs made the case early in 2012 that the prospects for equities relative to bonds “were as good as they had been in a generation”. Goldman 18 months on remains bullish, if a little bit more restrained. A new report from the bank’s strategists says the market has journeyed from an initial phase of hope for an equity market recovery into a longer growth phase driven on by earnings and dividends – and with more moderate returns and low volatility. The recent performance of the S&P 500 indicates that Goldman made a sound assessment in 2012, with the index up 18% over one year and 20% since the start of 2013.
Goldman also expects that returns through equities will continue to outperform other asset classes, such as government and corporate bonds. A more stable market is also anticipated to bring lower stock correlation within sectors and more alpha returns. They argue that better growth prospects and a lower risk premium should prompt investors to pay more for growth. “The prospects for very low interest rates should continue to favour high dividend yielding companies that can generate dividend growth and strong total returns,” they suggest.
Monetary stimulus, the end of fiscal austerity, an improved housing market and record corporate cash balances are all good signs for the US economy that should help it accelerate in coming quarters. As we have consistently pointed out in recent months, the Fed is going to trim or taper its bond purchases and is not about to engage in a pre-winter ‘ground zero’ hacking back of its $85 billion-a-month bond-purchase programme. These are positive conditions for US and global equities going into 2014.
The Bank of New York Mellon Corporation also makes a case that there are strong signals of a multi-year equity rally similar to the early 1980s in the US. Simon Derrick, chief currency strategist with BNY Mellon, observes a similarity between the last decade and the 1970s, and the Fed policy over both periods trailed headline inflation in the US. In the 1970s, the dollar went down, gold and commodities went up, and equities remained volatile; and that is what has occurred in the US markets in recent years.
BNY Mellon also points out that a new Fed chairman, Paul Volcker, turned his focus on inflation as the 1970s closed. The dollar rose and gold and commodities fell, and equities started a 20-year rally. “So, despite the fact that we were in a deep recession, equity markets looked forward to what they thought would come out of this and applauded a central bank that was focused on inflation,” says Derrick.
Bernanke’s concession in May that Fed policy may have played a role in allowing the US economy to form asset bubbles also points to a more conservative Fed stance on inflation, suggests Derrick. He argues that a rise in the dollar and the continued easing of commodity prices, particularly gold, could be good for equity markets. “The evidence so far seems to suggest that equity markets are taking it in their stride, not just in the US, but, elsewhere in the world,” he adds.
Waiting for Bernanke
The immediate aftermath of the collapse of Lehman Brothers was a period when financial markets and investors were close to a precipice – but those who kept or picked up equities, as well as bonds, and held their nerve have done well despite the volatility along the way. The S&P 500 total returns rose 42% from the Lehman crash on 15 September 2008 to the end of last week; the US index is up 97% since the announcement of the first QE package on 25 November that year.
The fact is that global corporates have started to look to raise equity as the wider markets anticipate Bernanke’s next move, displaying a growth confidence across boardrooms and among investors. Thomson Reuters data shows that there has been $491.2 billion raised in equity capital so far this year, which is up 17% from the same period in 2012. In the US, shares in LinkedIn are up 120% year to date; while shares in electric car market Tesla have almost doubled since it raised equity in May. Firms are going out to finance growth, after spending recent years building up cash reserves amounting to $6.7 trillion.
A rise in equity-raising activity can fan concerns over dilution of value, but it also provides liquidity in the market. And capital-raising activity can be good for share prices. Much of this capital raising is to fund merger and acquisition (M&A) activity, after companies held back from deal-making to repair balance sheets. The rise in benchmark US yields may also have pushed companies to turn from debt markets. M&A activity is already underway in the US, and beginning in Europe. Worldwide M&A activity is at $1.62 trillion so far in 2013, according to Thomson Reuters.
Some believe that US shares are looking overvalued on long-term measures such as the cyclically adjusted price-earnings ratio; others that this measure undervalues equities. But it is clear that the market is confident, although prone to bouts of nerves. EPFR Global data shows that investors have pushed more than $200 billion into equity funds this year, but have pulled back from equity and bond funds in recent weeks over concerns largely about US financial and foreign policy. A total of $11.4 billion of equity funds were redeemed worldwide in the seven days to 4 September, including $9 billion in US equities, according to EPFR. There were net outflows of $284 million from bond portfolios. This is not a stampede from the ring, but does indicate that investors remain nervous about macroeconomic developments in the US and abroad.
One of the features of the American investment landscape since 2008 is that as corporate profits in the US have recovered, they have outstripped the sluggish wider economy and employment numbers. Stronger signs of US recovery over the month may help assuage concerns that corporate earnings, swelled by buy-backs and cost-cutting, are elevated. It is also worth noting that corporate profitability and easy money has spelled good news for those with investments and assets, even if some see this as a relationship disjunctive with the rest of the economy.
The US economic recovery is still finding the vigour and level of momentum expected in an era of Fed monetary stimulus. Housing has also been under pressure recently with mortgage applications dwindling as financing costs and house prices rise. But investors can hope for stronger signs of a rise in economic activity over the coming months, and to find a less jumpy response to economic news. The Fed’s modest scaling back of QE, if it starts this week, will bring pressures. But in the five years since Lehman’s exit from Wall Street, one thing for sure is that those with equities who held their nerve amid the perils have profited – and deservedly.