HAMISH MCRAE: Market confidence is slowly returning and the investment community may be starting to look beyond the recession valley to the highlands on the other side
Here’s a puzzle. The Bank of England on Thursday did its best to scare us all by raising interest rates by the expected 0.75 percent to 3 percent and warning of the longest recession in a century next year.
And we’re warned that the November 17 fall statement will overwhelm us with higher taxes and austerity. So how come the FTSE100 index ended up more than 4 percent on the week, with Friday being one of the best days stocks have had all year?
Confidence: The investment community may be starting to look beyond the recession valley to the highlands on the other side
The best explanation comes in three parts. First, investors around the world have regained confidence that major central banks really mean what they say about their determination to crush inflation.
It’s true that two members of the monetary policy committee voted for a smaller rate hike, but that’s because of their inexperience with how markets react when they think the central banks have been soft on inflation.
Both the Federal Reserve and a week earlier the European Central Bank met market expectations with rate hikes of 0.75 percent, with promises of more. This is a global thing. The world’s central banks know that they have made a huge mistake with the ultra-easy monetary policies of the past decade and they must now correct it.
This renewed confidence last week helped the Bank of England take an important first step in phasing out QE by selling back £750m to the market of the government bonds it had bought under the QE programme.
The auction was more than three times oversubscribed. That says there’s a lot of demand for the UK government’s debt. Confidence is returning and markets believe the Sunak/Hunt alliance will regain control of the country’s finances. The second part of the statement is that investors are starting to position themselves for the next expansion. We all know that there is a global economic cycle that lasts about ten years.
The global economy is clearly heading for a downturn, which could last quite a while. The Bank of England thinks it will be long, but not particularly deep for the UK, and they may be right. But there will be an upswing in the cycle and since they only come once a decade, you don’t want to miss it. Equity markets are leading indicators of economic expansion.
So think about it. You want to take a bus that comes about once an hour, but is sometimes up to ten minutes early and sometimes ten minutes late. It’s much better to arrive 15 minutes early, even if it means standing in the rain, than showing up in time to find you’ve missed the bus and have to wait an hour for the next one.
It is still too early as there could be another downward move to the bear market, especially in high tech stocks in the US. That next bull market bus could be gone for a year or more. But I feel that the fear of missing out – the driver of that last frenzied phase of the bull market last year – will soon be replaced by the fear of being left behind.
The third part of the story is the realization that UK and to some extent European assets are undervalued. The UK remains out of fashion for all known reasons and our escapades over the past few weeks have not helped. European markets are out of fashion due to reliance on Russian gas and the threat of plant closures this winter.
The US remains more fully valued. So while the S&P500 index has fallen a long way this year, it still stands at a P/E ratio of 18. The Footsie is down just 2 percent this year and is at p/e of 13.4, and the DAX, that is 40 large German companies, stands at ap/e of 12.8. (Note, if you really want value, the Hang Seng index in Hong Kong is at ap/e of just over 6, but I can think of a few reasons why international investors might be a little nervous about putting money there. )
I think this value story will have legs for the next two or three years. The giant companies listed in London and Frankfurt (or even Paris) are really dependent on the global economy and can therefore look beyond the problems currently facing the UK and Europe.
None of this will make the coming months any easier for UK taxpayers and home buyers. The best that can be said about that is that next year with competent governance we will be heading for whatever; that with rates at 3 percent they could be three-quarters of the way to a peak of around 4 percent; and that the investment community may be starting to look beyond the recession valley to the highlands on the other side.