Michael Wilson cautions against getting carried away by the market sentiment
It isn’t just George Osborne who’s warning that 2014 is going to be tougher than some people expect. “A year of hard truths”, he promised on Monday during a speech at a meeting in the Midlands – with significant cuts already made, but with borrowing still at around £100 billion a year and an annual debt servicing burden of half that amount.
No, the hard truths are likely to come from elsewhere. From Fed Chairman Janet Yellen, for instance, or from struggling Tokyo, or even from Mark Carney at the Bank of England. Ms Yellen has already declared an imminent scaling back (“tapering”) of Federal Reserve support by $10 billion a month, and maybe more, and that’s almost certain to drive up the cost of borrowing and hammer the bond markets. Mr Carney, for his part, is still trying to insist that he won’t even consider a rise in the base rate until unemployment drops below 7%, but somehow his words don’t seem to match his body language.
Stock valuations are already stretched in the United States, where last year’s impressive catch-up in share prices contrasted with a relatively steady advance on corporate profits – and where smaller companies in particular have seen their valuations boosted enormously. Even in Britain, where the Footsie saw 14.5% growth last year, the advance in price/earnings ratios – both forward and historic – has been notable.
Now, you’re allowed to scoff at all that, of course. Any recovery from recession will favour smaller companies over larger ones, and the return of onshoring from China has done much to improve the prospects for some manufacturers. The housing recovery – both in the US and in the UK, where house prices rose by 8.4% last year – has put feelgood into people’s pockets even if it hasn’t hit their retail buying patterns yet.
We’ve already mentioned the likely impact of tapering on the US bond scene – in short, investors will sell, and those who stay invested will suffer like PIMCO’s Bill Gross, who had a miserable 2013. But the question many analysts are asking is whether the exodus from bonds will drive a surge into equities?
For some people, that’s a no-brainer. At a time when interest rates are on the floor, where else could the money go? And yet, as IFA Magazine reported last October, there is precious little sign of the Great Rotation that such an assumption would entail.
All around the world, private investors are largely keeping their money in their wallets and not piling it into equities. Trading volumes on most of the world’s premier stock exchanges are still well below historical averages – FTSE 100 volumes in early January have been barely half those of early 2013. And in Tokyo and Shanghai the new year has been welcomed by first-week falls of 2.5% and 3.5% respectively.
Something isn’t right here. We could always try and defend the optimists by remembering that the first week of January is often the time when the Santa Claus rally goes into reverse. And we could also say that uncertainties about the US borrowing limit – which falls due for upgrading in a week or so – may have spoiled things. But my guess is that the malaise goes a bit deeper than that. Many western markets are quite fully valued, and investors are right to stay on the sidelines.
Dr Doom’s Dissenting View
And yet the optimism won’t die. Nouriel Roubini, the 'Dr Doom' who predicted the 2007/2008 meltdown as far back as 2005, is now forecasting global economic performance to "pick up modestly" during 2014, in both advanced economies and emerging markets.
"The advanced economies, benefiting from a half-decade of painful private-sector deleveraging, a smaller fiscal drag, and maintenance of accommodative monetary policies, will grow at an annual pace closer to 1.9 percent," he declared on Tuesday.
And the QE taper will be slow enough to keep bank rates low, while China will avoid a hard landing.
So far, so comforting. But will that translate into financial market growth? Oddly, or perhaps not, he won’t say.