The first couple of weeks of this year witnessed quite some strength in the equity markets. At the time of writing, the FTSE100 and the S&P500 are both up over four per cent while the Euronext Top100 is up three per cent. With just over half the first month behind us, institutional investors started the year with a smile on their faces as the old trading proverb says: as January goes, so goes the year. We have been in this business long enough to know that this doesn’t always work and when it does, it hardly ever happens in a straight line.
As sure as night follows day, facts will be the next to follow- Karl Micallef
Market participants have been calling a turnaround in the equity markets for a number of quarters and on paper this does seem to be happening. The question is: why? Given the macroeconomic state of developed economies (and their respective growth outlooks) on the one hand and the current equity valuations on the other, would an investor (who is after total return, irrespective of whether this is generated through an income stream, price appreciation or both) instinctively opt for equity?
The 2012 rally in credit markets has created a headache for investors seeking to generate a positive real return through the generation of an income stream. Today, income-seeking investors need to take on more investment risk to achieve their investment return objective by either exposing capital to higher credit risk or longer duration. Faced with this investment choice, investors have, for quite a while, started considering equity as an alternative asset class. And here lies my headache.
Is the market being forced to expose investment capital to equity (due to the low yields in credit) in search for dividend yields? Or is equity fundamentally cheap in absolute terms given the economic growth potential that lies ahead? I find myself asking many more questions than I can answer at this point in time.
A few Central Bank meetings – accompanied by strongly worded market communications – provided the stimulus needed to start last year’s rally. However, as sure as night follows day, facts will be the next to follow – economic facts which (judging from the market assumptions) should show economic progress and growth being achieved in the not too distant future. Governors of various central banks have made it amply clear that they cannot solve the problems that exist – these need to be addressed by the respective governments. Central bankers have done what they could and may even keep doing more of the same, but governments need to do their part.
I still don’t believe that we are about to witness any reasonable growth within the developed economies, and by ‘reasonable’ I mean real positive growth. The issues at hand are deeply rooted and of a size which are too big to address successfully through meetings and other high level discussions. Financial markets are calmer, almost too calm since there seems to be no sign of growth picking up. One may argue that it is still too early to see such signs, yet the way financial markets have moved in the recent past seems to indicate that we have already started experiencing some degree of growth.
When one looks at the current economic realities it takes very little observation to notice the gap that exists between fact and expectation, and it would take one hell of a leap of faith to bridge this gap. The belief is that a concoction of ingredients to create a recipe which will help developed countries muddle through can always be found, though recent market history is littered with examples of steadily recurring blunders. The one common denominator is that such mishaps seem to occur at the same time the markets think the worst is over.
It is not the knowing that is difficult, but the doing, and I have not yet seen enough resolve to believe that the markets are only heading upwards. I remain hopeful that the market performance throughout 2013 will follow that of the first weeks of January. However, I would rather still err on the side of caution for now.
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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
Karl Micallef is an executive director at Curmi and Partners Ltd.