2016-07-14 08:22:03
Jul 13th 2016, 15:52 by Buttonwood
WHAT explains the recent highs in the American stockmarket? One explanation is
that the markets were nervous over the British referendum on the EU; before the
vote, it was cited as the biggest risk in the markets by 30% of fund managers
in a Bank of America poll. After the vote, however, investors seem to have
concluded it is mainly a UK and EU issue; indeed even in the latter, it does
not yet seem to be inspiring other countries to depart. So investors who were
sitting on the sidelines have piled back into equities.
However, the Brexit vote did drive government bond yields lower, pushing those
in Germany and Switzerland even further into negative territory. And it seems
likely to inspire a rate cut in Britain and may cause the Federal Reserve to
hold fire on further rate rises for a bit longer. In other words, the returns
in cash and bonds are pretty dismal.
In the circumstances, equities look like the only game in town. so the outlook
would have to be absolutely dreadful for investors to avoid them. And it's not
dreadful. The Atlanta Fed thinks that US GDP grew at an annualised 2.3% in the
second quarter; after a weak May, the non-farm payroll numbers in June were
strong.
The results season for the second quarter is just starting. Forecasts are for
an annual decline in earnings per share of 5%. That's not great. But BNP
Paribas points out that, on a quarterly basis, earnings will be higher than in
the first three months of the year. The impact of the oil price collapse and
the dollar's rise on corporate profits may be fading. In valuation terms, the
cyclically-adjusted price-earnings ratio is 26.2. That is high by historical
standards. But, of course, yields on bonds and cash are exceptionally low by
those same standard. So stocks look like the "least dirty shirt" on the washing
line.
Another factor may be that central banks are still pumping out liquidity; they
may not be buying equities directly but by forcing investors out of bonds, they
are boosting the stockmarket. Matt King of Citigroup notes a close correlation
between central bank asset purchases and the global equity market.
What will it take to drive the stockmarket down on a more sustained basis than
was seen in, say, February? It remains my view that this will not happen unless
there is a recession in America (or more generally in the developed world) or a
sharp rise in interest rates. The latter looks highly unlikely at the moment.
And while the world economy is hardly booming (see the latest numbers on
Chinese trade), it is still muddling along. None of this means the returns on
equities will be very high in a world of slow growth, of course, especially
given the starting valuations.