Market momentum has so far defied economic data in the UK, where the potential for another recession remains.
Elsewhere, major indices such as the US’s S&P 500 continue to climb. So, have we turned a corner when it comes to investor concern about the problems that persist in various developed and developing economies?
Certainly, there have been signs of greater conviction in the capacity of the European Central Bank (ECB) to cope with the aftermath of the financial crisis, in spite of political uncertainty in Italy during the recent elections.
While it would be overdoing it to say that the global financial crisis is over, one could argue that investors are starting to think more about the return on their money than the return of their money. Fear of losing it altogether has, until now, kept government bond prices very high, even in countries with very large debts.
Under such circumstances, the rally could continue for some time. However, it is important for investors not to be lulled by the flow of cheap money from central banks into believing that fundamental economic problems have been resolved. Western economies are generally weak and governments are struggling to reduce their debts. Reductions will have to be achieved through growth, austerity, inflation or default. Growth is hard to come by, austerity is politically challenging and default is a nuclear option that most countries will seek to avoid. That leaves inflation – a problem likely to mount if major central banks continue to print money.
Therefore, in our view, the perceived ‘safe havens’ of western government bonds are not in fact safe. They currently offer returns so low they are easily eroded by inflation. So it makes little sense to us to think of these as appropriate investments when seeking to preserve capital. Instead, we prefer to look among funds investing in quality companies with strong balance sheets which can maintain or grow their dividends across a range of geographies. Investors should also be alert to opportunities in emerging markets, where looser monetary policy and more stimuli could see growth re-accelerate. Certain emerging market sovereign debt too appears relatively attractive given the yields available.
China continues to fascinate us in spite of the fact that its corporate governance track record is poor. The economy has avoided a hard landing and the new government has taken a tougher stance on corruption. It has also declared its determination to reduce poverty through wage inflation, which will feed into imported inflation in the West. The good news is that business confidence is improving in Asia and yet local investors are far from euphoric.
In our view, there is little evidence to suggest that the West is about to regain the prosperity it enjoyed before the ‘global financial crisis’. It is therefore difficult to predict a return to ‘normality’, where interest rates rise to more typical levels and central banks rein in their money printing; the economic outlook is not strong enough.
If anything, monetary intervention could spread to new areas and we continue to be concerned that inflation remains the likely result.
John Chatfeild-Roberts is chief investment officer at Jupiter Asset Management
