My colleague recently commented about the growing disparity between expectations in the market and the economic reality on the ground. There is certainly a growing disparity between the two, but often stock markets tend to be leading indicators of what may lie ahead – one certainly hopes so in the current scenario.
Central banks have made it clear that they want to see asset prices rise- David Curmi
Justifying the best January for stock markets in 20 years is not a straightforward affair. Perhaps the presence of some good news has created a reaction to the constant flow of bad news that one has become accustomed to over recent years. Or are there real grounds for this optimism? Certainly one can point to pockets of positivity to clutch at. For example, in the US, house prices have risen for five consecutive months – and housing starts are at their highest since June 2008.
The reason for this optimism in the housing market is that in 2012, the US economy created 2.2 million new jobs. Although unemployment still rose to 7.9 per cent in January 2013 (from 7.8 per cent previously) this is perhaps a sign that workers who had given up on finding jobs are coming back into the labour market, feeling more optimistic.
Additionally, average hourly earnings are also on the increase, giving individuals more reason to be happy, or simply less downbeat. US GDP growth however has yet to reflect this optimism fully. After clocking growth of between two and three per cent in the first three quarters of 2012, it unexpectedly dipped to 0.6 per cent in Q4. Explanations for this lie in the effect of hurricane Sandy and changes in government spending patterns in the last quarter – however, the impact on the man in the street is still a negative one.
Forward-looking indicators are also implying a more positive trend in 2013. Consumer surveys from US to Europe and through to China indicate that businesses are more positive on 2013 than they have been for quite a number of months. In Germany, for example, the Purchasing Managers Index survey has risen for three months consecutively. According to Morgan Stanley, this is indicative of the development of a new positive trend which historically has led to stronger growth.
In China, the fall in GDP growth appears to have been stopped and fourth quarter growth registered at 7.9 per cent. Industrial production was also up over five per cent in December. In our backyard however, it is more difficult to find positive statistics to lean upon. Unemployment is still rising – now at 11.7 per cent for the whole eurozone – and this masks some pretty eye-watering statistics for youth unemployment in some countries like Spain where over 45 per cent of young people are unemployed. Similarly debt to GDP continues to rise – a reflection of the austerity measures that have been in place.
Governments today have more debt than at any time in the last 20 years. Perhaps one speck of good news lies in the fact that inter-bank lending is getting back to normal. This means that banks are no longer holding back lending to one another. This is a critical part of the financial system as it means that banks can begin to feel more comfortable about lending to customers if they are comfortable that their lines of credit are reliable. The fact that banks are also repaying some of the funds they borrowed from the ECB in the LTRO mechanism is another indication of normality getting back into the banking system. This is an important foundation stone for economies to have in place if they are to function.
There is another reason why perhaps markets are also rising – this is possibly linked to a new form of financial repression. Central Banks have made it clear that they want to see asset prices rise. The Fed has stated it and now the Bank of Japan has said as much. The ECB is more coy about this but the writing is on the wall. Essentially, what the central banks are doing are forcing investors to buy equities through the fact that they have kept interest rates so low (below inflation) for so long that it is not worth buying bonds any longer.
They are forcing investors into risky assets in the hope that the rising of such prices will create some form of inflation and avoid a deflationary spiral, and create a feelgood factor which, in turn, leads to an increase in consumer spending and economic growth. This is indeed a dangerous strategy.
As my colleague explained, economic conditions are mixed at best. True, there are positive signs but in Europe there are still a number of structural issues that must be addressed. The concern now is that without the pressures that the markets bring, these structural issues may not be addressed. Take a look at Italy – unbelievably Silvio Berlusconi is closing the gap on Mario Monti. The need for Monti’s restructuring is deemed less important now that there is less market pressure. This is dangerous as both in Italy and elsewhere in Europe (including Malta) structural changes are still some way from being fully implemented. Politics is currently the biggest risk to the much-needed reform.
From an investor’s perspective, the jury therefore is still very much out, and while there are positive signs, we remain cautious in our approach to committing capital. Risk, as defined in our books as the possibility of the permanent loss of capital, is still too high. This is not to say that there aren’t opportunities to be taken. On the contrary, our equity analyst has identified a number of high-quality companies with strong and sustainable dividends that fit within our profile. But we continue to balance these opportunities out with high levels of cash and until the signs clear we are unlikely to change this stance materially.
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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.
David Curmi is managing director of Curmi and Partners Ltd.