Equity markets: Safe haven in turmoil
There’s no getting away from it, the markets are in turmoil and confidence in the global economy is at low not seen since the depths of the credit crunch. Where next? Hal Catherwood, regional director for Scotland & Northern Ireland at Brewin Dolphin, reckons there’s value in them there equity markets
Among issues occupying equity markets recently, two have been especially troubling. The eurozone sovereign debt crisis has been troubling for some while. However, concern over debt sustainability has broadened more recently to include Italy and Spain, and more lately even France, thus bringing more into focus the problems for the banks and serving as a reminder of how destabilising this could be for the financial system.
On top of this, the loss of recovery momentum, and particularly that for the US economy, has shaken confidence in the global outlook. In dealing with their own budgetary problems, America’s leaders have not helped sentiment.
Yet, despite the quick, recent response by Standard & Poor’s in taking away the triple A rating for US government debt and warning of more downgrades, US Treasuries have not lost any of their appeal as a safe haven in times of uncertainty. Not only that, but their appeal has also been enhanced, for better or worse, by the US Federal Reserve’s commitment to keep the funds rate at its current setting for a minimum of two years. Yields on two and 10-year Treasuries have taken out the historical lows of the financial crisis.
Yields on 10-year gilts hit new record lows late last month, helped in part by Chancellor George Osborne’s determined efforts to retain the UK’s triple A sovereign rating, and in part by the weakness of the UK economy. While the Bank of England has not been as explicit on interest rates as the Federal Reserve, the message behind the latest Quarterly Inflation Report is much the same.
Weakness of the economy is likely to persist, the risks to GDP growth are judged to be on the downside and inflation is expected to start falling around the turn-of-the-year to a little below target over the medium term. All of which suggests no change in interest rates for the foreseeable future.
It may be that, as far as the eurozone is concerned, contagion will persist and that the European Central Bank’s purchases of Italian and Spanish government debt will prove to be no more than a short-term fix. The end game of debt restructuring and debt forgiveness may be unavoidable in spite of measures agreed last month in relation to a second bailout for Greece. No one knows where all this will lead but some of it — and maybe even a good deal of it — could be discounted already.
The recent reporting season in the US and the UK has shown that companies in the main are performing very well, have strong balance sheets and that the strong dividend yields investors can find remain attractive in this low-interest-rate environment. Overall, equity markets are deeply into oversold territory — it is seldom you will find pretty well every single constituent of a leading index like the S&P 500 below its 50-day moving average, while the prospective PE ratios for the FTSE World Index are back to where they were ahead of the recovery in equity markets in the spring of 2009. Furthermore, the bond-equity earnings yield ratio for the FTSE World Index has dropped to a new low for the life of the series.
These or, indeed, any such measures can be no more than a guide. Still, they illustrate in some sense the dichotomy that has arisen for the developed economies between a floundering in political leadership to confront the issues and the corporate world in which earnings are growing strongly. While we accept that the risk of a relapse into recession has risen for the US, we also still feel that the odds favour modest growth ahead. On that view, and even allowing for earnings downgrades, there is value in equity markets for long-term investors.