The storm is (mostly) behind us, though I expect an unpredictable economic shock in the coming months, says HAMISH MCRAE
It’s time for a break. The long Easter weekend gives us a moment to reflect on the difficult first quarter of this year and to reflect on how markets and the economy will develop in the coming months.
In times of financial stress, you usually get a seismic event that marks the turning point. In the case of the 2008/9 crisis, there were some early shocks, including the collapse of Northern Rock and Bear Stearns. But it was the failure of Lehman Brothers – I believe the failure to save Lehman Brothers – that brought the global banking industry to its knees.
The scars remain. The government still owns 42 per cent of Royal Bank of Scotland, now renamed NatWest, and the share price is about half the level it paid when it was bailed out.
The question now is whether the rescue of Credit Suisse, itself triggered by the bankruptcy of Silicon Valley Bank in America, is that turning point in this cycle. I’d like to think so, but somehow it feels like more shocks are to come. Things are not nearly as fragile as they were in 2009, but I don’t think we’re through this yet.
If so, how can the not-too-bad performance of stocks on both sides of the Atlantic be explained? The S&P 500 is currently up about 7 percent year-to-date, but is well below its late 2021 peak.
Sailing into calmer waters?: Things are not nearly as fragile as they were in 2009, but we may not be through this yet
The FTSE 100 is up 2.5 percent, although it has passed its February peak this year. Put it this way, equities are not pricing in a severe recession, or even the bleak longer-term outlook predicted by the International Monetary Fund.
Its managing director, Kristalina Georgieva, said last week that the Fund believes global growth over the next five years will be about 3 percent, the lowest since the early 1990s. Equity markets look ahead, so if growth is going to be weak, how can companies make enough profits to justify current ratings?
There is one clear difference between the US and UK markets, which is that US companies are valued much higher than their UK or European counterparts. Shell is at a price/earnings ratio of 5.5, while Exxon is at 8.7. But they are broadly similar companies.
This kind of inequality has led to the idea that companies should move their listings to New York, but that seems like a strange argument. After all, global investors are perfectly capable of buying stocks wherever they are listed, and the smart money is coming to the UK and European markets precisely because they offer more value than US ones.
In the medium term, I expect these disparities to diminish, the question is timing, and whether this will imply a downward valuation of US equities or an appreciation of equities here.
There are also more subtle differences. In the US, there is a tug of war between fears of a recession (highlighted last week by Jamie Dimon, head of JP Morgan – see page 78) and hopes that pressure on the banking system will prompt the Federal Reserve to raise interest rates.
Here the tension is more between the UK economy remaining out of fashion and currently our markets offering good value. I prefer the UK because fashion will eventually turn around and buying cheap should be a wise policy for long term investors.
So what should you pay attention to during the summer? Five thoughts, against which people can test their own expectations. First, the decline of the dollar may be accelerating. Remember those gloomy predictions that the pound would go to parity? Well, it’s already back around $1.25, the highest in 10 months, and my goal would be $1.40 by the end of the year.
Second, stocks will be bumpy all summer, and I could see US stocks skyrocketing. But in the autumn, the markets expect a reasonable recovery next year.
Third, growth in the UK will be quite positive this year, at between 1% and 2%, which is much better than those gloomy IMF forecasts. Next year the prospects look even better.
Fourth, inflation will fall rapidly by the summer, with the possibility of hitting 2 percent near the fall. Other major economies will see similar numbers.
One last thought. Years ago I spoke to someone at the Bank of England about their handling of the 2008 crash. ‘We didn’t do well,’ they said, ‘but we did well enough.’ While I expect an unpredictable economic shock in the coming months, it will be cushioned well enough to only make a temporary dent in the broader outlook.