The ride since March 9th this year has been a pleasant one for recent buyers of shares, and some relief for those who held on during the dark days of the winter. It just goes to show what quantitative easing can do to asset prices.
In the middle of the week there were poor house price figures from the US, which the market chose to ignore, and better consumer confidence figures which the market liked. Clearly there is plenty of money around at the moment, and investors are worried about being left out of the upwards move.
It’s not a very stable world underneath the action being taken by the US and the UK. The over extension of cash and credit in the Western economies was part of the problem that led to the crash. Extending more is only a temporary expedient. The rest of the problem was made up by the huge imbalances between the successful export economies of Japan, Germany and China on the one hand, and the big importers like the US and the UK on the other.
To reach a more stable world we are going to need more exports from the borrowers, and more spending from the savers. We need China, Japan and Germany to import more, and we need the US, the UK, and Ireland amongst others, to spend less and borrow less. In the short-term money printing is going to encourage more of the same, with more spending and public borrowing in the West. The exporters still look to the USA as the importer of last resort to get them out of recession, whilst Western consumers hope the heady days of spending more are not cancelled but just a little delayed this year.
It’s not all bad news. The big fall in the pound should cut imports and boost exports, helping to right the bloated balance of payments deficit. The US seems to be allowing some fall in the dollar, with something similar in mind. The recessions themselves in the US and UK, coupled with the shortage of credit, are leading to less private borrowing, and to more repayments of debt. Encouraging more saving is difficult given very low interest and savings rates. As the world economy slowly recovers from the dreadful shocks of the banking crash and the violent stock cycle we have just witnessed, any stirring anywhere in the world is welcome and will help activity and asset prices off the lows.
There are two things we should worry about as we enjoy the upwards movement in equity prices. The first is how the US and UK authorities get themselves off quantitative easing. At some point they have to announce that their purchases of bonds are coming to an end. They may decide to run the shorter bonds they have bought to redemption, but there will still be quite an impact from the cessation of easy money purchases of bonds, against a background of large issues of new ones to fund the deficits. That is why we have been recommending selling out of gilts whilst the government is still buying.
The second is the impact of the crash and of a probable slower long-term rate of growth in the heavily borrowed countries on equity values. Investors as they become more optimistic assume that prices will return to where they were at the previous peak, and then exceed them. Japan after 1990 shows this is not necessarily the pattern after a severe credit crunch. People evaluating US and UK shares have to understand that some value has been lost for the longer-term. Some companies and sectors are going to find it difficult to get back to the profit and dividend levels of before.
That is why we favour more investment in faster growing economies where the prospects for higher earnings and dividends are clearer. Quantitative easing will boost share prices in the short-term, and will help economies turn the corner. It does not represent a permanent solution to the problems of heavy public deficits and too many imports which still remain for the US and UK. Working those out will change quite a lot.