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Right for the wrong reason - international markets update

Richard Clark and Simon Patterson, private bankers at Barclays Wealth and Investment Management in Newcastle, provide their monthly insight into international markets.

Another month, another new high for the S&P500 – at least, that’s how it’s seemed this year, with the biggest, direction-setting US stock market making an all-time nominal high eight of the 11 months to date.

The latest surge has reflected a growing awareness that the Federal Reserve is unlikely to “taper” its bond purchases as quickly as had been expected – March 2014 now seems the most likely date. Having championed developed stock markets these last four years, and seen the US market – our favourite for most of that time – almost triple in total return terms from its low, it may seem a bit churlish to question the nature of the latest advance. To be clear, we still do not expect a deep or lasting setback any time soon: a big fall in earnings is not on the horizon and in the meantime valuations look pretty forgiving. Nor are we tempted to recommend a shift back into government bonds, which still look pricey to us (and more so as they have clawed back some more of the ground lost since April). However, it is difficult not to be a little unsettled by the recent, widespread focus on the transient generosity of central banks.

Back in 2009, as the Federal Reserve and the Bank of England (BoE) saved the world, such a focus made sense; and again in late 2012, as the European Central Bank showed itself capable of improvising brilliantly in shoring up the euro. But we should be hearing less now about market liquidity and more about the characteristics of the assets being bought. If the central banks won’t take the punchbowl away, at least investors might save themselves from the hangover risk that could yet develop if the party continues in this vein. As we suggested a few months back, investors can have a good time sober. Because at some stage we will have to face the reality that central banks and their bond purchases don’t create lasting value or growth. On a medium-term view, they don’t even drive the general level of interest rates, as BoE chairman Mark Carney’s experiment with “forward guidance” has illustrated in the UK. And they will stop and eventually reverse.

We’re optimistic that markets can again refocus from finance back to fundamentals. Sustainable growth is likely out there, and is not driven by financial balance sheets, credit creation or even interest and exchange rates. We doubt that much damage is being done by central banks’ erring on the side of liquidity: we argued last month that they are not taking as big a risk with inflation as many fear, and we do not agree with the ‘CAPE’ and ‘Q’ valuation metrics that suggest stocks are already expensive. But stock market inflows driven by growth and profitability would feel a little more secure.

This was posted in Bdaily's Members' News section by Barclays Bank PLC .