This feature is part of our FREE daily Money Morning email. If you’d like to sign up, please click here: sign up for Money Morning.
Earlier this month, a survey of fund managers by Merrill Lynch found that the mood of investment professionals had taken a sharp turn for the worse.
A full 72% said they thought the global economy was getting weaker, the most downbeat result in 10 years.
There are very few sure things in investing – but one is that when fund managers agree on something, you should do the exact opposite. And inevitably, stock markets around the world ended the month with their best week in ages…
Stock markets in developed economies had a great run last week. The FTSE 100 rose 255 points, the biggest weekly gain since the market reached its last low point in March 2003. Markets in the US were also strongly ahead by Friday’s close, while Japanese markets had their first weekly gain in a month.
But investors shouldn’t pile in indiscriminately. Two of these markets – the UK and the US – are looking distinctly peaky. One of the reasons for the gains was because data showed that the US economy is growing more slowly than economists had expected.
US gross domestic product grew at a 2.5% annual rate in the second quarter of the year, compared to 5.6% in the first three months of the year. Analysts had forecast 3%.
Isn’t that a bad thing? You might well think so – but at the moment, markets are more worried about the Federal Reserve raising interest rates ‘too much’ and tipping the US into a full-blown recession (you can read more about this in last Thursday’s Money Morning – Can Ben Bernanke save the US economy? (/file/15955/can-ben-bernanke-save-the-us-economy.html)). The worse the economic data becomes, the less likely the Fed is to hike rates – or so the theory goes.
So the more bad news the US and the UK see, the more cheery the markets are likely to get – at least in the short term. But when the slowdown starts to bite, the markets may not be quite so relaxed.
But Japan is an entirely different matter. The economic news just keeps getting better. And Russell Napier, author of “Anatomy of the Bear”, reckons the country is still near the start of a massive bull market which could eventually see markets rise another 300% or so from current levels.
Another 300%? Japan has already risen by 40% in the past year – something that puts many analysts and investors off. However, Napier points out that this is normal for a stock market in Japan’s situation.
“The four great US bull markets of the 20th century began in similar style,” he points out. The bull periods – starting in 1921, 1932, 1949 and 1982 – all happened when “deflation, or the threat of deflation, ended and price stability returned.”
As far as Japan goes, “the good news is that the best is yet to come. The US experience suggests that the price of equities should rise by somewhere around seven-fold in the course of the full post-devaluation recovery.”
This is heady stuff. A seven-fold rise from the Japanese market’s April 2003 low point would take the Topix to around 6,000, which is where Napier believes it will be by 2015. That’s from a current level of around 1,560.
This may seem far-fetched. But Napier’s premise is essentially very simple. It’s based on the observation that “around two-thirds of this return will come from higher valuations and thus, exceptionally high earnings growth is not necessary to produce this bull market.”
In other words, the gains are not based on soaring company earnings. The real driver will be the shift from bonds to equities as the favoured asset class. This makes a lot of sense – as an economy moves from deflation to inflation, stocks are naturally more attractive than bonds as an investment.
But even if you don’t accept Napier’s premise, it’s hard to deny that Japan looks by far the best bet of the developed world economies at the moment.
Companies are reporting forecast-beating earnings. June saw consumer prices rise for the eighth month in a row. Prices are now up 0.6% on last year, excluding fresh food costs. The jobs market tightened further, which bodes well for wage rises, and therefore consumer spending.
Japanese companies are also managing to pass costs onto consumers – something our own manufacturers in the UK are still struggling to do.
In fact, the good news is coming so quickly that Junichi Makino at Daiwa Institute of Research in Tokyo said there is now “a chance that the Bank of Japan will raise interest rates again as early as in October.”
The markets will have to get used to the idea of rising interest rates across the world. Interest rates in Australia are almost certain to hit 6% this week, while rates in Europe and even the UK may well rise this week too.
So does it make more sense to buy into countries like the UK, where massively indebted consumers are trembling at the thought of how another quarter point hike will hit their mortgage payments? Or would you rather buy into Japan, where an early hike in interest rates just means that the economy is doing even better than expected?
We don’t think it’s a tough choice.
Turning to the wider markets…
Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email.
The FTSE 100 rose 45 points to 5,974, boosted late in the session by the weak US economic growth figure. Mining giant Xstrata rose 7% to £23.01 as Inco pulled out of the running to buy Canadian miner Falconbridge. Insurer Prudential was the among the weakest blue chips, falling 3% to 577.5p as first half results missed City forecasts. For a full market report, see: London market close (/file/16049/london-close-two-month-high-on-us-rate-hopes.html)
Over in continental Europe, the Paris Cac-40 rose 27 points to close at 5,028. The German Dax-30 gained 46 points to 5,705.
Across the Atlantic, US stocks jumped on hopes that the Federal Reserve will stop raising interest rates amid slowing US economic growth. The Dow Jones Industrial Average rose 119 points to close at 11,219, while the S&P 500 climbed 15 points to 1,278. The tech-heavy Nasdaq rose 39 to 2,094.
Overnight in Asia, hope over US interest rates helped stocks. The Nikkei 225 climbed 113 points to 15,456. News of better-than-expected growth in industrial production during June also boosted sentiment – industrial production rose 1.9%, the fastest in seven months.
Oil prices rose in New York this morning, with crude trading at around $73.30 a barrel. Brent crude was a little higher too, at around $73.45.
Meanwhile, spot gold was trading at around $637 an ounce after heading as high as $638.50 on Friday. Silver was lower, trading at around $11.41 an ounce.
And in the UK this morning, first-half results from publishing group Pearson have beat analysts’ hopes. Pre-tax profit came in at £31m for the six months to June 30.
And our two recommended articles for today…
Will the Middle East crisis derail the global economy?
– Back in May, bearish Morgan Stanley economist Stephen Roach ventured to suggest that the global economy was finally on the mend. In the light of current geopolitical tension, he is reassessing his newfound optimism. To find out whether he thinks the world economy is resilient enough to withstand an escalation of the Middle East crisis, read:
Will the Middle East crisis derail the global economy?
Is the US headed for bankruptcy?
– Even the US government’s own predictions show federal debt soaring to impossible levels, says Bud Conrad in The Daily Reckoning. What will this massive deficit mean for the dollar? And could interest rate rises solve the problem – or will that just make things worse? To find out why gold should now be considered a core holding in any investors’ portfolio, read: Is the US headed for bankruptcy?