Market uncertainty - tis ever been thus

Friday, 23rd March 2018 10:29 - by David Harbage

Equity markets are spooked by the uncertainty caused by fears of a 'trade war' or what could be more accurately presented as de-globalisation. This prospective reversal in the trend of liberal trade between countries and continents may not seem like a major depressant on markets - such as a geo-political (Middle East war), natural catastrophe, (think Kobe) or economic (turn of cycle into recession) event - but its impact on corporate profitability is likely to be more direct.

It could just turn out to be noise, but there again markets - which are composed of both rational long term investors and emotive, financially geared traders - will tend to display a more cautious or fearful 'knee jerk' reaction in the early days of such negative news. A financial commentator's statement "that economists have predicted 6 out of the last 2 recessions" always amuses me. One has to be invested in the stock market to gain the full benefit of ownership (much of which resides in the income stream, incidentally) and the nervous who cannot contemplate any temporal loss of capital worth should not be there.

Another factor behind the recent weakness in markets, appreciated by professionals but which has not received the media attention is the soundings coming from central banks - in response to improving economic development, both at home and abroad. The new head of the US central bank (the Federal Reserve Bank) at the recent FOMC (Federal Open Markets Committee) meeting raised interest rates - as expected - but guided that further rises (probably three of 0.25%) can be expected later this year and in 2019 (likely two hikes of 0.25%). Mark Carney, the governor of the Bank of England, has made similar noises and, this week's publication of Meeting minutes on voting, we saw a 7-2 vote in favour of no change in the Bank's base rate. The surprise was to see two dissidents who believed that an immediate rate rise was appropriate for the domestic economy. 

Consensual expectation is for a 0.25% rise in UK interest rates in May (to 0.75%) with another hike of the same magnitude later in the year. Perhaps positive momentum in the most recent economic data (more employment, unemployment down to 4.3%, revival in wage inflation - exceeding inflation of 2.7%), points towards three upward moves this year.

Against such a backdrop of more rapid tightening in money, there are a number of financial assets which are likely to be uncomfortable: most obviously, the bond market and rate-sensitive areas of the equity market. Hence the impact on the listed house builders, as investors fear that heightened mortgage costs will choke off demand. Another area of perhaps greater concern would be companies carrying high levels of short term debt.

The other factor which has been frequently highlighted in this blog is the valuation of equity (company shares), and more pertinently their relative worth - as compared to other, alternative assets, most obviously cash. The US equity market is considerably more highly valued (by reference to profits produced by their leading stock exchange listed companies) than the UK - where dividend income of 4% remains attractive compared to short and longer term interest rates. This week's woes at Facebook show the very high level of anticipated growth - which is already built into the price of such web-based, technology-driven businesses - and the impact of any deterioration in the business model. 

In such an environ of heightened nervousness, investors should ensure that they are comfortable with both the fundamentals of any individual company or an asset class - as well as the attractiveness of the relative valuation. That interest rates are rising is a testament to the fact that the global economy is progressing and a recognition that governments could not continue to 'print money' in order to support an economy. Debt is accepted as a norm - and as a positive - by many (especially consumers), but while it can be a necessary evil at critical times, its true nature is only usually revealed when the cost of servicing such debt (interest rates) rise. A move to more normal, by reference to history, levels of economic activity, levels of debt, interest rates and inflation is to be welcomed. However, getting there may not be painless.

Equity markets can perform well in times of rising interest rates - the pace is critical (influenced ideally by good guidance) - and perhaps, as the decade of earning more from dividend income than bank or building society deposit accounts may be ending, company shares with sustainable dividends can enjoy an upward reappraisal. 

The greater uncertainty is likely to emanate from the current trade war - with perhaps the Brexit discussions playing second fiddle to the global tensions. Politicians rather than economists will dictate and, looking at some of the biggest players, the markets might well be turbulent with good cause. Against such a backdrop, the writer would encourage investors to review their own risk investments - SWOT assessment of the strengths, weaknesses, opportunities, threats - and then consider the relative valuation. Remember the old saying,"It's not timing the market, but time in the market that really counts" - an exhortation to be patient and not to panic and exit at an inopportune moment. This blog would add another suggestion to investors: ensure that your head rules in investment selection decisions and don't allow emotive forces of greed or fear to overrule.