Market View - February 2012

Global stocks have now officially entered a bull market following the rise of 20% in the MSCI Global index from its October 2011 lows!

It is extraordinary what a new year can bring and while the global economic and debt dynamics have changed only very slightly, the all important market perception appears that most downside risk is already priced into markets, while little of the upside potential (assuming we can somehow muddle through with a little help from further quantative easing measures when necessary), is factored in. This combined with increasing momentum on the back of improving US economic data, and receding emerging Asian market hard landing concerns is helping investors confidence in stocks generally, despite the fact that a long term solution to the euro-zone crisis remains frustratingly out of reach.

Additionally it is of course the fourth year in the US Presidential cycle when historically the US equity market has mostly enjoyed positive returns with more often than not most other global stock markets also rising higher on its coat tails. Research carried out by a number of market historians and analysts has identified there is some correlation between American politics and market returns, and interestingly stock market lows tend to occur with remarkable consistency around about the midyear congressional cycles, or two years before the presidential elections, while being invested during the latter half of a presidential term has consistently given the better results!

The S&P 500 has risen 4.41% since the start of the year, which supposedly also augurs well for the rest of 2012. According to Bloomberg, a positive first week of January (this year the index was up 1.61%) has resulted in positive returns 73% of the time (since 1927) with an average annual return of 9.8% compared to just 2.2% per annum average in those years when the first week of the year was negative!

All major equity markets were positive last month, with the best performance coming from the two emerging market giants China and India with the Hang Seng up 10.61%% and the BSE Sensex up 11.25%. While some of the omens for global equities undoubtedly appear promising, the party may not yet be over for the longest bond bull market in history, according to a recent Buttonwood article in The Economist newspaper (In praise of pessimists).

While warning that “the last time long term Treasury bonds yielded 2.1% was in 1949, and investors who took the plunge into Treasuries then earned an annual negative return of 1.6% over the following 30 years” it also reminds us that this time the circumstances are different because “the central bank is one of the main purchasers of Treasury bonds in an effort to keep yields low”. Accepting that part of the reason for the low yields on US Bonds is down to “optimism that American politicians will agree on a long term plan to sort out the government’s finances”, the Buttonwood article also suggests that the main driver is “pessimism about the outlook for other asset classes.”

By contrast, domestic European stock valuations are now very cheap (notwithstanding of course, that they could get decidedly cheaper were the Euro zone to disintegrate), while Asian corporates could potentially be described as reasonably valued. Additionally, many of the market’s economic fears about emerging giants China and India appear to be receding as evidenced by the positive returns from their respective stock markets thus far in 2012, and the negative sentiment that has affected the Indian market in the past few months is now receding with the rupee seemingly having found a floor and inflation expectations moderating, while the outlook for China is also much more positive on a macro level with inflation having declined 250 basis points from a high of 6.50% last summer.

While we remain cautiously optimistic on the outlook for global equities and in particular US and emerging market equities, we remain mindful that many concerns remain, not least as highlighted in January’s commentary that on a cyclically adjusted price earnings ratio (PE10) American equities are quite expensive. The requisite mix of ingredients necessary for 2012 to produce positive returns therefore will be as much about US corporate earnings not disappointing as it will upon the global economic backdrop continuing to reassure markets that a double dip recession is not on the horizon!!