Last year saw equity markets continue to plough ahead, with stronger growth in both the UK and US economies. As predicted, despite the threat (and start) of the US Fed tapering and the introduction of forward guidance into the UK, US equity markets hit record highs and UK, European and Japanese markets all saw strong positive returns. Whilst yield curves began to steepen following the fear of interest rate rises in both the US and UK in the coming couple of years, it would appear that the management of forward guidance by the Bank of England and Federal Reserve in the US acted to ensure that, after the initial panic, there is an acceptance that base rates will only rise when the economy is ready.
So to 2014. After the strained optimism of last year, with the bears and bulls fighting it out in almost equal numbers, market analysts and "experts" almost to a man are making optimistic predictions for the markets and economy in both the US and UK. I mean why shouldn't they? The US and the UK are growing again and look like picking up speed, unemployment on both sides of the Atlantic is coming down, the US has finally managed to come to an agreement on its budget and some measures of business confidence in the UK are at a 20 year high. All this appears to have convinced even the most skeptical (aside from the permanently pessimistic and critical Robert Peston) that the only way for markets is up.
Renowned economic journalist Anatole Kaletsky sees US economic growth hitting 4% this year (a level many see as the sort of figure for sustainable growth) whilst also seeing global stock markets still having "a long way to go". Even in a potentially rising interest rate environment he believes that this is no sure reason to suppress equity market advances claiming that in an growing economic climate equities rise alongside bond yields. He even believes that the Euro will eventually weaken later in the year leading to a recovery in the much battered economies of Southern Europe. But whilst he is perhaps overly optimistic about the year ahead he is not alone in his assertions for a bumper year. A recent Daily Telegraph article approaching several market participants saw almost complete agreement that the FTSE 100 in the UK was set to drive even further forward. Whilst some estimates merely predict a modest movement above the 1999 high of 6,930 (it's currently around 6,750) there are many who are predicting a further 11% uptick to 7,500, meanwhile predictions from Citibank suggest an 18.5% increase to the 8,000 mark are not out of reach. An article by Business Insider saw similarly bullish sentiment for the year ahead on the US market. Not one analyst asked predicted a fall in equities over the year, with most predicting at least a 7% return, a figure which would extend a rally already over 170% since the low of 2009.
Even Dr Doom himself, Nouriel Roubini, is sounding remarkably upbeat in his start of year predictions. He was one of the few to predict the 2007/8 crash and someone who continued to predict doom and gloom in both his post crash book Crisis Economics and subsequent articles. The more reassuring part of Roubini's article however is that it is more cautiously optimistic. Whilst he sees modest growth in the "advanced" economies, he still believes that most of these economies will still remain below the sort of growth levels required to drive forward into a full recovery and economic boom. He also believes there has been a stabilisation of what he terms "tail-end risks", the kind of risk such as a euro implosion or US debt default likely to plunge the world back into crisis.
The seemingly rosy picture painted by those "in the know" is often used by everyday investors that now is the time to pump their savings right back into the equity market which so burned pension funds and personal investments just 5 years ago. It's this exact reason why a note of caution needs to be sounded to all those preparing to do just that. It is at the point of most exuberance that bubbles tend to get carried away and investors feel the need to get in before it is too late. The cost of this is the all too familiar losses seen by many retail investors post 1999 and 2007. The fear at the moment is that whilst we seem to be moving forwards in terms of improving fundamentals this does not guarantee that things will be rosy for years to come. There are still items for concern which could affect the outcome of the next few years.
Among them the US debt ceiling debate is still continuing to rage on with the current extension only providing enough funding until February 17th. Whilst it is estimated that there will be enough funds available to allow the Treasury to function for about a month after that, the issue remains that this is still to be resolved in a conclusive manner. If further dithering in early February around negotiations to extend the ceiling fails to lead to a comprehensive extension, it will continue to cause unnecessary uncertainty on a global level. The eurozone, whilst seeing a marginally improving situation, is still sitting on an employment level of 12.2%, with more than twice than percentage of 18-25 year olds unemployed. In order to see a true recovery (and avoid similar catastrophe in any further recession) they will need to work substantially to resolve the structural issues currently associated with having a series of entirely independent states sharing the single currency.
As the UK and US continue to push towards an improvement in terms of general economic conditions, there also remains the fear that rising market interest rates could halt any economic growth. I believe the reality is that whilst private consumption is seemingly helping to drive forward the current growth, a gradual rise in rates as confidence increases may help to improve an important part of the economy, that of business investment. Whilst rising rates increase the cost of borrowing, one of the current issues is still the reluctance of banks to lend. An increase in rates will enable banks to get a higher margin on their loans and as a result could see more companies able and willing to carry out the sort of capital expenditure required to provide the boost to the economy enabling it to reach the "escape velocity" level. In turn this should lead to the substantial increase in corporate earnings required to justify a further equity market rise.
The recovery phase of the economic business cycle is often believed historically to last between 3 and 4 years, which in itself has led many to question whether the current recovery has much longer to run. However recent analysis mentioned by Lance Roberts of STA Wealth and Cullen Roche of Pragmatic Capitalism has suggested that the previous 3 recessions (focusing on the US) have actually seen longer more gradual recoveries. The suggestion for this is that the downturns themselves are less severe due to the active management by central banks once the crisis begins to unfold (like we have seen so far). The longest recovery was apparent in 1991 which saw an almost 10 year period of growth, with the following in 2001 being 6 years in growth. If this adjustment in the timing length of economic cycles continues to hold true it would suggest that the current improvement may still have at least a couple more years left.
Such analysis would indeed suggest for now that the only way is up, but we should always be wary about relying too much on history to enable us to time market entry and exit (there is a reason they say past performance are not an indication of future returns). As mentioned, there are still factors at play which could ultimately cause the existing recovery to stall, but the current facts point to a permissible optimism for now. As always though in what we do, we must think for the long term and not lose sight of the realities. As I always like to say, if you're not prepared to lose it, then don't be prepared to risk it.
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