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Brian Tora: Eurozone gives markets pause for thought

Appetite for risk returns although uncertainty dogs Europe

Brian Tora MM blog side

Despite a continuing flow of relatively good corporate news, markets have done very little in the week following my last efforts at encapsulating investor sentiment.

Part of the reason was a brief flurry of concern in the Eurozone. A political scandal emerged in Spain, resulting in a collapse in bond yields, while the re-emergence of Silvio Berlusconi as a contender in this month’s general election in Italy was enough to send the Italian stock market into reverse.

Chartists believe that European bourses have broken their uptrend as a consequence. Certainly, nervousness has returned, with the continuing debate over the European Union budget adding to the uncertainty. Perhaps the biggest disappointment has been that Europe’s political leaders have not used the time generated by the ECB’s implicit support of the single currency to take decisive action. Still, Europe could be worth watching.

In America, where more robust market conditions remain, the main worry seems to be over inflation. This is not necessarily bad for equity markets, though it would be another nail in the coffin for bonds.

The question is, what might the Fed do if the rise in the cost of living turns out to be ahead of their expectations? The cynic in me says very little, given the ameliorating effect inflation could have on debt. I take this as another positive sign.

Meanwhile, indications are that commodity prices might start to tick up again. Gold certainly seems to have lost its shine, trending sideways for some little while, but one report I read from an economics consultancy suggests that we could see a firmer trend in the price as the year progresses. Part of the thinking behind their prediction is the expansion of the Fed’s balance sheet, itself a reason for believing inflation in the US could rise.

Of course, to see firmer prices amongst metals, we need to see a resumption of rising demand from China.

This is less easy to predict. A firmer currency and higher transportation costs are resulting in a migration of manufacturing back to those countries that have helped propel China to the premier position it established. As for locally generated demand, there is something of an issue here as well.

I have referred before to the way in which demographic pressures will start to influence how society develops and markets behave.

This is not to say I am pessimistic – merely alive to the considerable changes that seem inevitable. Already an ageing population is exerting significant influence in Japan. In China the situation is exacerbated by the single child policy that has been in force for some time.

The distortion this has produced in China is considerable. Because male children have been favoured over female – perhaps resulting in abortions and convenient early deaths amongst girl children – it is estimated that around 100 million Chinese males will be unable to find a wife. Add to that the lack of a labour force coming forward to help support the growing retired population and you start to see the problem. Investment themes will surely follow, though they are hard to identify at this early stage.

Meanwhile, if you would like another indication that an appetite for risk has returned, it is worth looking at the behaviour of private equity investment vehicles.

In the aftermath of the financial meltdown in 2008, discounts on quoted private equity investment trusts ballooned to over 40 per cent. Today, according to a report from a leading broker, they have shrunk to 17.5 per cent – still more than the average for all trusts, but an indication of a return of faith in the sector. Perhaps there will be more good news to follow.

Brian Tora is an associate with investment managers JM Finn & Co

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