It has been our contention that with such an extended degree of leverage within the developed world (a hangover from the last 2 decades), the only solution was an extended period of very low interest rates to keep the credit system from failing – thereby permitting both corporates and individuals to raise their savings rates, both of which have or are now happening. This reliqification process has been at the expense of the public sector which has extended its debt levels in Keynesian style fashion to be counter-cyclical.
However, and unlike previous economic cycles, the second phase of the recovery led by corporate capex (capital and labour) is being truncated in the developed world as the previous debts are still very high and the corporate sector is nervous. With investors looking to the private sector to take up the running they are hiding as governments and global authorities fail to address what looks to be more like profligacy than stimulus. In many ways this is encouraging. Europe has been living in a dream world for decades and the capital markets are saying reform or fail – ultimately a necessity. Ditto the US where the deck chair shifting fails to address legitimate structural issues.
The question is how far is this priced into asset markets – gold continues to romp away based upon negative interest rates, huge investment buying and fear. Bond yields are plunging to the 08 lows even though the financial system is less geared and notionally less vulnerable. However, as developed world and indeed developing world growth rates fade, the move in yields is understandable. Equities are moving to discount a recession – with PE multiples already at compelling valuations, a recession-inspired type decline in earnings implies more potential downside for equities but the discounting mechanism is rapid and of course the recessionary scenario may fail to materialise. Longer term, the structural growth of the emerging markets remains the key hope for earnings globally – if not the answer to the domestic issues in the developed world.
The markets are currently in a negative feedback loop which is only likely be to broken by strong action from the authorities. The markets are rioting to force their hand – a process where compelling valuations offer limited protection. Investors’ actions here must be dictated by time horizons. Key blue chip yielding stocks are at generationally cheap levels and already appear to offer good value. A long-term mindset would suggest a long-term view would offer significant upside to patient investors. Those of a more nervous disposition may wish to wait and see how inspired and complete the actions by the authorities actually are before committing to the markets.
By Peter Toogood
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