I came out of lunch with James Abate, manager of the PSigma (shortly to be Miton) American Fund, last week to discover the European Central Bank had unexpectedly cut interest rates. The worry seems to be the subdued level of inflation in the single European currency zone.
A cut had been on the cards but was not expected until the New Year. It served to push the euro down against both sterling and the dollar.
Mario Draghi’s move also unsettled markets. There is an interesting comparison to be made here with investor attitudes towards interest rate policy in the US. There, even a hint that rates might rise (or, at least, monetary easing would be reduced) was sufficient to undermine confidence. In Europe it seems that further easing is more of a worry than a comfort.
Of course, the central bank’s action highlights the fragile nature of many European economies. Deflation is a real worry if growth cannot be stimulated. Given the experience elsewhere in the world, it must be considered as doubtful that a cut like this will actually make much difference.
In America it seems that tapering may now be off the agenda. Not only is the incoming governor of the Federal Reserve Bank noted for her dovish stance (she was, after all, one of the architects of quantitative easing) but some of the signs emerging from America suggest the recovery may be running out of steam.
Not that James was overly pessimistic in his expectations for the US stock market – merely cautious. He pointed to a tailing off in the recovery in house prices, with an overhang of stock actually pushing down values in some instances, and a market rally that had taken the valuation of smaller and mid size cap companies to levels likely to be vulnerable to any bad news. Larger cap stocks, on the other hand, were less extravagantly priced.
With the stated aim of producing superior risk adjusted performance, it should, perhaps, come as no surprise that he favoured the top end of the capitalisation spectrum but the arguments certainly seemed compelling. He also favoured businesses prepared to react positively to adverse conditions by cost cutting and downsizing – maybe even returning cash to shareholders rather than investing it.
Another risk was a disappointing results season. We know that businesses in general acted swiftly to position themselves appropriately to reflect the changed conditions, following the financial crises, but this is now history, so the period when companies were able to exceed expectations was always bound to end. The problem today is that analysts are still factoring in profit increases that might not materialise, given that profit margins and return on capital probably peaked last year.
Overall, though, he was upbeat, expecting more opportunities than threats in the months ahead. There was, he felt, room for multiple expansion in some areas, with the valuation gap between small and mid cap stocks and the very largest companies in the American universe as wide as it has been for some time.
Meanwhile, if we want convincing that there is money around to invest and the appetite for risk has returned, look no further than the launch of Twitter onto the listed stage. Not only was the company able to get the shares away at well above the range expected but early trading saw the price double at one point. Remember, this is a company which has never made a profit and has a business model that even now cannot guarantee revenue.
It made me think back to the turn of the new millennium, when even the craziest technological idea would find backers to take it to market. Still, Royal Mail, altogether a more established business – even if its own model looks under threat – attracted similar enthusiasm. Providing the politicians do not succeed in screwing things up for business, perhaps we can retain a positive stance for the future.
Brian Tora is an associate with investment managers JM Finn & Co