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Brian Tora: It is not just the weather that will make it a long summer

Market conditions recently have been a little like the weather – disappointing. June may have seen shares recover a little of the ground lost earlier during the year, though the second quarter was still negative for equity markets overall, but July so far has failed to see any of that modest momentum maintained.

And for once it is not just Europe that is dampening investor sentiment.

Last week the minutes of the most recent meeting of the Federal Open Markets Committee were published. The FOMC is the US equivalent of our Monetary Policy Committee and is charged with setting interest rates. It seems that further easing from the Federal Reserve Bank would only take place if the economy worsened significantly – not what investors wanted to hear.

Then we had doubts that Spanish banks would actually receive the funding that European finance ministers had promised. This threat appeared to recede as a €30bn package was promised last week, though it seems that Germany still has the ability to throw a spanner in the works. No wonder our own premier central banker, Sir Mervyn King, referred to Europe as a cloud overhanging our own economic recovery.

And the situation at home did not appear to improve either. Marks & Spencer’s Interim Management Statement confirmed that life on Britain’s high streets continued to be challenging, while luxury goods retailer Burberry disappointed with its figures. People do seem to be tightening their belts in the face of continuing uncertainty. These are hardly the conditions that encourage risk taking.

I was encouraged to read in the latest PSigma bulletin on their income fund that experienced managers like Bill Mott were similarly nonplussed by the drivers of the market. The combination of a difficult global economic environment and continuing uncertainty over the future for the single European currency zone make it hard to believe that equity markets can resume a sustained uptrend anytime soon.

Yet ten year gilt yields languish at 1.7 per cent – way below the current level of inflation, while there are plenty of household names in the FTSE 100 index offering dividend yields well in excess of the rate of our cost of living increase. Perhaps defensive, high yielding blue chip shares will have their day after all. That is what Mott and his team clearly believe.

There doesn’t seem to be much comfort to be gained from markets elsewhere in the world either. Looking at what took place in the second quarter of 2012, all major markets were down on balance, despite an improved picture in June.

The main European markets were the worst performers – hardly surprisingly – but emerging markets also took a tumble, no doubt as a consequence of a weakening picture in these previously high growth economies.

What might reverse these trends and encourage investors to step back up to the plate?

Clearly, some more decisive action in Europe would help, but a pick up in the developing world would be even more useful. Much of the recent decline in inflation can be attributed to falling commodity prices – a consequence of slowing economic growth in China and other important manufacturing countries. Greater demand would rekindle price rises and stimulate inflation.

In the end some inflation is surely necessary if the debt problem is to be resolved. This means more money printing by the likes of the US and us, while Germany will have to relax its austere approach to handling the crisis.

This may all take some time to achieve, so in the meantime the sideways drift looks set to continue, with investors jumping at shadows generated by European indecision. It could be a long summer.

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


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