Many of the Brothers’ Grimm fairy tales begin with an uneven bargain: a cow for some beans in Jack and the Beanstalk; a baby daughter for some flowers in Rapunzel. These uneven bargains, after deep despair, are usually resolved with a happy ending. Global markets reach the 29th day of the second month of the year on something of a high after the pain of 2011. The CBOE’s VIX index has retreated significantly from its highs of Q3 and Q4, is back at the levels of last May to July and has been stable throughout February.
The story of market returns this year is one of declining fear, and returning risk and growth appetite. European (ex UK) equities have led markets up this month, +7% in sterling (and +11% this year), driven higher by very positive returns from northern Europe. The MSCI Emerging Markets Index is up 4.6% so far in February and up 14.7% in 2012, both in sterling. The broader MSCI ACWI is up 4.8% this month and 9.2% so far this year. The NASDAQ is up nearly 15% in dollars so far this year, leading the S&P at 9% and Dow at 6%.
Even Japan has been positive, with the Nikkei up over 10% in February and 15% year to date, although yen strength has eroded these in sterling. Commodities have also been strong: gold is up 14% in 2012; silver is up 26%; copper is up 14%; and oil (WTI) is up 8%. “Risk off” assets have suffered on a relative basis but major bond markets have been fairly stable so far this year, with the US 10 year bond yield easing up to 1.94% from 1.88% at the start of the year.
Since the end of September last year global equities have rallied 17.5% in sterling. A good deal of this reflects the reappraisal of the panic that set in about the euro, but much of it must reflect a more optimistic investor perception of the future. Average equity valuations are not at bargain basement levels. The ACWI stands on 11.9 times next year’s profits, forecast to rise 8.4% according to brokers, and on a dividend yield of 2.6%. Europe is cheaper at 10.8 times profits and Japan more expensive at 14 times, according to FactSet.
For equity markets to kick on from here has to be a re-rating based on expectations of growth rather than just the hope of further stimulus. Today’s second round €590bn LTRO is another example of the tremendous injection of liquidity into markets over the past few years in order to ease the pain of adjusting the enormous credit expansion of the 2000s and the consequent over expansion. While these have succeeded in managing the bouts of fear that have struck equity and credit markets, the signs are not clear cut that economic growth has so easily responded to the balancing of credit contraction and monetary stimulation.
The United States has been doing the best in this regard, with 2011 GDP growth of just 1.7%, but now running at an annualised 2.8% based on Q4. The Euro area GDP growth in 2011 was +1.5% but based on Q4 is now running at -1.3% annualised according to The Economist, and although 2011 CPI was 2.7% compared with 3.1% in the US, euro area unemployment was higher at 10.4%. Japanese 2011 GDP was -0.7% and Q4 (annualised) running at -2.3%, with CPI down -0.4% in 2011 and unemployment 4.6%. China’s GDP grew by 9.2% in 2011 but was at a slower annualised rate in Q4 (8.2%), although CPI was 5.5% for the year.
Markets will be hungrily looking ahead for signs that the massive stimulus in place represents a good bargain with a happy ending of returning economic (and profit) growth offsetting the bouts of pain associated with retiring unproductive capacity and shrinking the debt that produced it. But if markets do follow fairy tales there are likely to be further bouts of jeopardy ahead first.
Issued by: Rupert Caldecott, CIO of the Global Asset Allocation Team, Dalton Strategic Partnership LLP, an investment management boutique in London founded in 2003 by the late Andrew Dalton