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Everything is rosy for global stock market investors. The FTSE 100 is around its highest level in six years.
Meanwhile, the Dow Jones in the States continues to set fresh record highs on a weekly basis.
Is this likely to continue? Will we see both indices end the year higher than they are now – or are we headed for tougher times ahead?
Stock market volatility (as measured by the ‘fear gauge’ of the Vix index, which is based on the prices of options linked to the S&P 500 index) is near all-time lows. It’s rarely been cheaper to insure against the threat of a downturn in the market.
But as most of our readers know, the more people that agree about something, the more money you stand to make (or avoid losing) by doing the exact opposite.
Right now, the Vix suggests that everyone’s a bull. No one can see any way for things to go wrong, and so volatility will keep falling (even though it’s at record lows) and stock markets will keep rising. It’s a perfect world.
Except, of course, we all know there’s no such thing. And just because you can’t quite imagine how things could go wrong, doesn’t mean that they won’t.
In any case, it’s not terribly hard to imagine a large number of things that could go wrong. There’s the big geopolitical things that may or may not happen (ideally the latter) – like bird flu, or war in Iran / the Middle East.
But then there’s the tiny little things – a quarter point interest rate hike here, another one there – and before you know it, suddenly the waves of liquidity that have fuelled the global asset price boom have receded, leaving a lot of beached investors without their swimming trunks.
Global liquidity growth is not the easiest thing to measure, but Merrill Lynch reckons that it has receded sharply since a peak in mid- to late-2005, and is now hovering around 10% a year. That’s still pretty chunky – but we could be nearing a danger point.
Gary Duncan in The Times says there’s “a good case for believing” that we could be seeing “increased market turbulence, if not turmoil” later this year. Why? Because history suggests that “volatility tends to spike upwards when global liquidity growth slides into single figures.”
And it looks like this is set to happen – the UK is set for at least one more interest rate rise (and we suspect this will surprise to the upside, once again); the eurozone is still on the upwards path; and most importantly of all, it’s only a matter of time (perhaps even as early as this Wednesday) before the Bank of Japan hikes rates once again. 0.5% might not be very high, but it would be double what the key Japanese rate is today.
But why should we be worried? After all, interest rates are only heading higher because the economy is so strong. Well, that’s an arguable point in itself, but let’s let it stand for the moment.
The trouble lies in, as Duncan puts it, “the unusual risks accumulated by institutions during the recent period of abundant liquidity, stimulated by earlier, historically low, official interest rates.
“As ample supplies of capital fuelled a boom in demand for investments of all kinds, the resulting rapid rise in asset prices depressed the returns being earned, triggering the well-known ‘search for yield’ with moves into riskier asset classes and increased use of leverage.”
In other words, slack lending standards have enabled lots of people to use too much borrowed money to invest in overly-risky assets. That might be OK while markets are utterly laid-back, but as soon as someone realises that these might not be safe bets – for example, the markets might start to realise that the large proportion of sub-prime borrowers reneging on their debts is just the tip of a massive iceberg – then the race for the exits will begin.
So what does all that mean for the FTSE and the Dow? Duncan puts it gently: “What is apparent is that present market exuberance is likely to prove, if not irrational, then at least excessive.”
That’s not to say that there aren’t any stocks in the FTSE 100 worth investing in. BP and Shell both look good value, trading on p/es of around 10, with hefty dividend yields of around 4%. Then there’s the drugs sector, with GlaxoSmithKline looking historically cheap, as Charlie Gibson wrote in MoneyWeek recently.
But if you’re asking if you should put money in a FTSE 100 tracker right now, we’d advise against it – it’ll probably be lower at some point this year.
Turning to the stock markets…
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In London, stocks ended their three-day run of gains on Friday as the FTSE 100 index closed 13 points lower, at 6,419. Retailers Kingfisher and Next topped the blue-chip leaderboard on positive broker comment. For a full market report, see: London market close.
Elsewhere in Europe, the Paris CAC-40 ended the day in the red due to a mixture of profit-taking and weakness amongst financial stocks. The index ended the day 7 points lower, at 5,713. In Frankfurt, the DAX-30 closed 1 point lower, at 6,957.
Across the Atlantic, the Dow Jones achieved its third record close of the week on Friday, having gained 2 points to end the day at 12,767. The Nasdaq was a fraction of a point lower, at 2,596, and the S&P 500 fell one point to close at 1,455, although both indices were higher over the week as a whole.
In Asia, the Nikkei neared a seven-year high today, gaining 64 points to end the session at 17,940, with the average boosted by a strong retail sector.
Crude oil was 46c lower at $58.93 today, whilst Brent spot was also weaker, at $57.17 a barrel.
Spot gold was last quoted at $672.60 this morning and silver was at $14.02.
And in London this morning, shares in J Sainsbury had already climbed by as much as 2% following further reports of a possible private equity takeover at the weekend. The Sunday Telegraph reported that a fund backed by the government of Qatar had been involved in discussions about Sainsbury with fellow retailer, Marks and Spencer. The news follows reports earlier this month that CVC, Kohlberg Kravis Roberts and Blackstone Group were considering a joint bid for the supermarket.
And our two recommended articles for today…
Should you worry about foreign takeovers?
– A Spanish company owns the UK’s main airports and French firms own our utilitities. So should we be worried? Not really, says Brian Durrant. to find out why he thinks our extremely open market is a strength rather than a weakness, see: Should you worry about foreign takeovers?
The carry trade: a tsunami in the making
– What is the carry trade – and why does it present such a serious threat to financial markets? For Jeremy Batstone’s explanation of the risks inherent to this $1 trn trade, read: The carry trade: a tsunami in the making