It all looks too good
April 19th, 2011
Investors have got over the wobbles of February. The ides of March were good for the bulls. The main investors and commentators are in love with risk again.
The beginning of the year saw quite a sell off in emerging markets. Brokers rotated their more active clients into western markets, on the grounds they were better value. Some houses were sure Japan was at last going to come right. They argued that the yen was about to fall, and the profits of the exporting businesses to soar as a result. The US powered ahead on the back of easy money newly printed by the Fed. Even the EU started to make more headway, based on the strength of German exporters. As the quarter advanced fear gripped investors again, and shares relapsed. Japan was hit by the cruel tsunami. The EU was subject to more rumours of debt and deficit difficulties for some of the peripheral countries, and more worries about bank losses and bad loans. By March these clouds started to lift, and investors once again decided the world was growing, interest rates in the west were still low, and risk was back in fashion.
At times like these it is important to sit back and ask yourself what is the underlying reality? The sad truth is that higher interest rates and rising inflation are obvious in the emerging world, and a background threat in the advanced world. People differ on when European, UK and US official interest rates will rise, but few doubt the next move will be up. UK inflation is obstinately too high. Indian inflation is a big worry. Brazil and China are fighting back hard against price rises with higher interest rates.
It is true the US will have another better year. It is true corporate profits and earnings are doing well generally. The US is still working its way through its second quantitative easing programme, which will help lubricate markets for most of the second quarter of 2011. It is true that even with the monetary brakes being applied India, China and Brazil will grow well again this year. The problem is next. The efforts to slow things down may impede western recoveries. The Europeans may have more trouble with their banks and deficits. Countries like Ireland, Portugal and Greece do not have easy ways out of their crises. The UK will suffer a severe squeeze on consumers from its policy. Even the US will have to turn to deficit reduction sometime.
The easy call is to say avoid longer dated and government bonds in this climate. Higher rates and more worries about debt and deficits is not a good background for fixed income government bonds. Shares are more difficult. It’s probably one of those markets where you should book some profits when everyone is back in love with risk, and buy when there is a prominent crisis on the front pages. For the time being shares look at best fairly valued. China begins to look cheap, and should be the first of the major economies to get through the tightening phase of the cycle. Parts of the West have yet to begin their monetary tightening, despite rising inflation worldwide. Now is not a time to get carried away by the love of risk. The Middle East is still in difficulties, the oil price has risen a lot, inflation and higher interest rates are part of the background, and the world economy may slow next year.
As published in Investment Week
