Equity markets have delivered positive, but not spectacular, returns to sterling investors so far this year.
European markets started 2015 strongly, but then gave up some of those returns in the second quarter, the pullback being amplified by concurrent euro weakness.
Nevertheless, a sterling return of almost 4.5 per cent on the Euro Stoxx 50 index is not bad compared to other developed markets. The US S&P 500 index has grown less than 3 per cent, although mergers and acquisitions (M&A) has driven the Nasdaq index up almost 8 per cent.
In the UK the surprise general election result gave a fillip to the market, but the rally failed to take hold and the FTSE 100 index now sits 4.5 per cent below the new high it touched at the end of April.
Meanwhile in Asia, markets are livelier. Japan’s Nikkei 225 index is up 12.5 per cent in sterling terms (15 per cent in yen) and Hong Kong’s Hang Seng index grew nearly 16.5 per cent in the year to June 9. The Japanese market suggests confidence in the ongoing reforms of the country’s economy and corporate governance, while the Hang Seng reflects a combination of relative economic growth and a growing bubble in mainland China stockmarkets.
Mergers and acquisitions
M&A news has been supporting markets. Royal Dutch Shell’s bid for BG Group in the first quarter was joined by other high-profile and high-value deals announced in Europe and the US, such as Charter Communications’ offer to buy Time Warner Cable.
In the background, economic growth has been slowing. In the developed world, leading indicators in the UK and US point to a slowdown and Chinese growth appears set to continue to be lacklustre by its own standards. However, the outlook in Europe looks relatively better and Japan’s leading indicators show promising signs, so the global picture is not uniform.
Looking out to the second half of the year, what can we realistically expect from equity markets?
Valuations are not standout cheap on a historic view and indeed long-term measures of value are beginning to look stretched. We are not within bubble territory (with the exception of mainland Chinese markets) but this is not a time to be complacent, either.
That is not to say that equities are bound to pull back, but the valuation elastic is being stretched, so it would be optimistic to expect a sustained rally in the second half of 2015.
It is a truism to say that valuations only matter when they matter but they are good indicators of future long-term performance. Current levels suggest returns at the lower end of the range for the next few years, unless we see meaningful earnings acceleration (and, by implication, economic growth) or markets fall such that valuations settle back.
Clearly my hope is for the latter, but one ought to be mindful of the other outcome. One should not forget the impact of central banks’ monetary policies that could continue to support markets, but the law of diminishing returns does appear to be setting in.