InvestmentsJan 21 2013

Much work still needs to be done

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As the European sovereign-debt crisis grimly rumbled on and the global economy faltered, it was up to the rate-setters of the world to give the market direction – and to soothe frayed investors’ nerves.

It is testament to policymakers’ guile that all the major equity indices recorded near double-digit gains by the end of the year. No mean feat given the sizeable headwinds that buffeted the market.

The man with the most on his plate was European Central Bank president Mario Draghi – and he proved he was up to the task. He certainly had his work cut out.

From a looming credit crunch at the start of the year to the threat of a possible Greek default “Super Mario” was forced to turn to the central bankers’ time and again.

The Federal Reserve and Bank of England continued to sail the good ship quantitative easing [QE]. Authorities in China and Japan were also pulling the policy levers. These actions have all given a much-needed jolt to equity markets.

But there is one thing that was notably absent from markets last year – confidence. Whether it be in the political institutions themselves or the policies they’ve initiated, markets have remained sceptical.

Bond markets have so far held faith with the UK government’s fiscal plan A, but the cracks grow deeper with each new missed forecast. Even China, the world’s one economic bright spot, has started to wane. Its housing market – for many a bubble that’s already popped – could be the market’s next big headache.

Central bankers, too, have begun to question the potency of their policy responses. Bank of England governor Mervyn King, for example, recently suggested that QE could be reaching its effective limit – and he would know: his Bank owns roughly a third of the gilt market. Even liquidity-addicted markets have their saturation point.

Then there is the US. Gridlock has gripped Capital Hill since the 2010 mid-term elections, making the nation all but ungovernable. President Obama secured a second term after an ill-tempered election campaign and his first test was negotiating a deal before the US tumbled over the ‘fiscal cliff’.

US firms are sitting on more than $2trn (£1.25trn) of cash. If confidence is restored, this money could quickly be put to work. Spending on capital expenditure, investment and hiring would increase. This would restore confidence to US households and rejuvenate spending.

Europe’s politicians must also show they are willing to make the tough decisions. Never-ending austerity is not the answer. Mario Draghi has bought them valuable time – they must grasp it.

As for equity markets, the past year’s rally has been welcome – but much work needs to be done. If we are to enjoy sustained market growth we need to see some corroboration in the form of stabilising corporate earnings and improved dividend expectations.

Richard Dunbar is investment director of global equities at Scottish Widows Investment Partnership (Swip)