Since March 2009, rallying equities and low Treasury yields, combined with a weakening dollar, have pointed to the fact that markets believe the authorities (particularly the Federal Reserve) will resume quantitative easing in response to the continued faltering of the global economy.
However, given that risk assets have come so far over the last 16 months, it is unlikely they would experience a further boost from another round of QE and current prices seem to be already discounting it, so the risk to the upside is limited. On the other hand, the likelihood of markets selling risk is much greater.
Although the bulls can legitimately claim that corporate earnings have beaten expectations, the outlook for the next six months is less positive, pointing to a period of pressure on margins and unsustainable earnings’ upgrades.
The S&P is vacillating between 1,000 and 1,100 at present but with troublesome macro-economic issues waiting in the wings, it seems a matter of time until the market moves bearish.
Investors are long since bored of the European sovereign debt horror story but this could be refreshed by a default or debt restructuring in Ireland or Greece. Greek bond yields are nearing levels of before the EU/IMF bailout, showing the market is unconvinced there is sufficient firepower within Europe to keep Greece afloat. This hypothesis will be tested more fully at some point. There is undoubtedly a huge amount of political will invested in the success and stability of the European project but it will face a trial by fire in the coming months as the market seeks to determine how close it is to breaking.
Risk assets have been led higher by emerging markets and commodities since March 2009. Investors are fascinated with the idea of emerging markets as the new engine of the global economy, with China leading the way. One of the problems with the Chinese model of capitalism is that the authoritarian government, through intervention and manipulation, can distort market behaviour. So although China faces the same challenges as other, less opaque economies, it can take longer for problems to render themselves visible in the region.
Simon Mungall is head of multi-manager at Ignis Asset Management