After a rather difficult period for stock markets and particularly risk assets such as equities in the spring, the second half of the year has been rather more kind and a reasonable recovery has ensued.
Despite the continuation of generally disappointing economic data for perhaps longer than was anticipated, investor sentiment has been helped by global central banks which have continued to support economies and particularly fixed income markets through their funding activities.
Easing tensions in the Eurozone, helped by aggressive statements by the European Central Bank to the effect that it will stand behind the Euro, combined with encouraging housing and employment data in the US and a growing belief that the dip in Chinese economy activity is temporary, have all provided a base on which a mild improvement in investor sentiment has been established.
The muted pace of economic activity is not helpful to the outlook for corporate activity and recent corporate earnings statements have generally cautioned against any significant improvement for the next year or so. Nevertheless, corporate balance sheets are arguably in the best shape they have been for many a year and are certainly able to withstand a more cautionary outlook for economic activity for the next year or so.
The debt crisis is far from over, however, and it will be many years before the legacy of the massive buildup in debt by governments and individuals can be restructured. Europe’s issues remain incredibly difficult to call but we should not underestimate the political support for the European currency framework.
The passage of time and a political will globally to move forward is strong, and it does now appear that politicians that were operating somewhat unilaterally are becoming more collective in their policy making.
There will be bumps in the road ahead, but the determinant over what return one achieves from an invested asset is not necessarily the quality of that asset, but the price one pays for it.
In this respect, after years of derating, equities, and to a certain extent other risk assets, have reached a point where they more or less adequately reflect the economic stresses brought on by the financial crisis. Equally, assets that are perceived to be ‘safe havens’ have been chased so hard that the return profile from these, given inflated prices, might very well disappoint in the future.
The derating of equities and the re-rating of fixed income assets has been extended and exaggerated as investors have become increasingly sceptical about the ability of economies to grow under the burden of debt.
However, we are confident that the level of global economic growth will not actually materially deteriorate much further. Growth is unlikely to be strong in 2013, but risk assets typically perform well when the momentum of the growth rate of the global economic cycle starts to improve and we believe that we are either at or very near that point. So far, such an outcome does not appear priced in.
While issues over the US fiscal cliff and unrest in the Middle East will continue, together with ongoing questions over the shape and direction of Europe will continue to act as restraining factors, ultimately what is most important is not the pace of economic activity and corporate profit or dividend growth but the outcome relative to expectations priced in.
Right now there appears almost no hope that things can get better, which of course they can and probably will in the years to come.
Gary Potter is co-head of multi-manager at Thames River