It’s been a month for head scratching.
September is historically the weakest month of the year for the stock market, yet we have apparently just enjoyed the best September since the 1930s.
Government bond yields went even lower, hinting at entrenched caution. But equities have been going up, suggesting greater confidence about a continuing recovery in the economy at large as well as company profits. This doesn’t obviously make sense.
High yield bonds (what used to be called junk bonds) have returned to pre-Lehman levels. It’s as if the last couple of years didn’t happen – some would argue we are now in a bigger hole (the “age of austerity”) than in the lead up to Lehman’s failure.
For example, the US economy is turning down when it should be recovering, and China is doing the opposite when their authorities have been trying to take the steam out of it. Indebted countries are still accumulating higher levels of debt (the age of austerity has barely begun), the global imbalances which existed prior to 2008 remain in place, and anxiety is growing that the US will lose patience with China not adjusting its artificially low currency – a trade or currency war at this delicate stage for the global economy would be a disaster.
The easiest way to understand the markets dichotomy is in the context of the different types of investors and the expectation of “QE2”.
Equity markets are not just suffering low volume, but also the twitchy influence of investors with a short timeframe, which, in the case of high frequency traders, is measured in seconds.
Another round of quantitative easing is expected in the UK and US (so-called QE2) and the 2009 precedent has encouraged punters to buy equities ahead of developments. In early March 2009 the Bank of England began quantitative easing, and it was no coincidence that the FTSE 100 low occurred in the same timeframe, at 3512. It was well understood that if money is injected into the economy it leaks first into financial markets – 2009 was a text book example of this.
The problem now is that investors are, to some extent, already anticipating another round of QE, and the market can’t discount the same event twice. So if QE2 transpires, the upside could be limited. On the other hand, if hopes of QE2 fade, markets will head lower.
In contrast, more cautious investors, often with a longer timeframe, have been buying gilts both as a safe haven (with expectations of deflation) and because QE2 may see the Bank of England increase its buying of gilts, pushing yields lower still (and prices up). As with equities, there will be renewed volatility if hopes of QE2 are dashed, or markets begin to fret about sticky inflation, or demand a higher yield to reflect the huge supply of new gilt issues which is in the pipeline.
Turning to the UK in particular, the corporate sector is in good shape, accumulating cash just as did their Japanese peers over the last decade. For now at least this cash will not be used to increase their payrolls; not until there is much more confidence about future demand. But thatcash does enable companies to increase dividend payouts, which is very positive for longer term investors.
Taking into account the movement in the last month, our technical indicators suggest that the FTSE 100 can move higher, perhaps getting to 6000. But the nature of the group of flakey investors that are pushing it higher, and the range of global problems that could fizz at any time, give us little conviction that this rally is sustainable.
