With the European Central Bank’s big liquidity injections behind us, a predominant concern among investors has been a fear that the rally in equities might be running out of steam.
I see the US-led recovery in global growth as more sustainable. I’ve used periods of market weakness over the past few weeks to build overweight position in risk assets, for the first time since July 2011.
The US and euro area economies are seeing their most pronounced economic divergence since the German reunification boom in the early 1990s, this time in America’s favour. US service sector confidence is robust, car sales are booming, home builders report an increase in the traffic of potential buyers and unemployment is making post-recovery lows. Meanwhile, euro area activity is sub-par, confidence in Spain and Italy is at recessionary levels and unemployment has risen to a 15 year high in spite of a tight labour market in Germany. German strength is a positive. An improving global backdrop could quell the euro crisis for a few months. However, austerity and political uncertainty will limit the upside for Europe’s economies and we expect US equities to add to the 70% outperformance they have registered versus Europe since the financial crisis began four years ago.
Despite a challenging economic environment, there are reasons to believe the US economy will continue to lead a recovery in global growth. Global stock markets started 2012 on a very strong note as central bank easing moves to stem the global crisis took effect. The old adage that investors can stop panicking as soon as policy-makers start seems to be ringing true.
There is a strong case for buying equities now (and US equities still look more attractive than their European counterparts). The US Federal Reserve has shown a deep commitment to promoting and protecting US growth. It has left the official interest rate at a staggeringly low 0.25% for over three years. Since the credit crisis in 2008 it has implemented two massive rounds of quantitative easing. The result has been a huge injection of liquidity into the US economy on a scale never seen before.
While some investors may now be worried the recent rally has stalled, it is hardly surprising that markets, including the US, pulled back in the face of the Greek debt restructuring deadline. Sentiment had become excessively bullish, while the European Central Bank’s second three-year liquidity injection came and went.
There are some headwinds. In recent weeks geopolitical tensions have impacted on the price of oil and inflation has been rising. However, Fed chairman Bernanke can point to the Fed’s newly articulated 2% inflation target and the degree of slack in the US economy to justify looking through any short term rise in inflation. The Fed also has both the motive and the means to signal continuing monetary support should the economy show signs of faltering.
Presidential elections in the US could mark a change in policy. Growth is by far the best way to reduce indebtedness but the US was punished for its approach when Standard & Poor’s decided to downgrade US government debt from triple-A last year. Time will tell whether America follows Europe into austerity after November’s elections. My suspicion and my hope is that by then the economic debate will have resolved itself in favour of continued fiscal support rather than the depressionary policies of default and deleveraging.
Bull factors
- US-led recovery in global growth
- Monetary policy remains loose with more Chinese ease to come
Bear factors
- Short economic cycles, reliant on support from policy makers
- Ongoing geopolitical tensions could push oil higher.
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