Equity markets seem to be partying like there’s no tomorrow. After a surge in recent weeks equity markets in the US, Germany and the UK are close to all-time highs.
If you had bought UK equities a year ago, five weeks before the EU referendum, you would have made a 27% return.
Investors are increasingly venturing into riskier assets as confidence grows. This year emerging market and euro area equities have easily outperformed last year’s stars, US and UK equities. The value of previously unloved assets, such as Greek equities and euro area banks, has shot up by 20% since January.
Why are investors so cheery?
Part of the story is that the global economy, and profits, are accelerating, and at a rather faster pace than expected. Markets, like people, love positive surprises, and the global economy has delivered a few in recent months.
Growth in emerging economies, rather than crashing, as many feared, has accelerated. China has dodged a hard landing and the Indian economy has moved into top gear.
Activity is the rich world has also firmed, led by an improvement in US activity. Fears of a post-referendum recession in the UK have dissipated and the euro area is doing better than expected – and well enough for the European Central Bank to declare victory against deflation. Japan, an economy that gets little coverage in the West these days but is the world’s third largest, seems to be turning the corner. Japanese growth forecasts for this year have tripled to 1.4% in the last 12 months.
First-quarter company results show that the recovery is feeding through to profits. More than 70% of US and European companies which have so far reported have announced stronger-than-expected profits.
Despite widespread concern about political risks markets have so far shrugged off two huge political surprises, in the form of Britain’s Brexit vote and the election of President Trump.
More recently, victories for mainstream politicians in the Dutch and French general elections have cheered investors. So, too, has Angela Merkel’s surprise success, earlier this month, against the centre-left SPD, in Germany’s most populous state, Nord Rhine Westphalia. That outcome has bolstered expectations that Ms Merkel will win against her main challenger, the SPD’s Martin Schulz, in September’s Federal elections.
Equity markets have certainly bought into the idea of stronger global growth. And the hard data, by and large, confirm that global activity has picked up. But we need to keep this in perspective. Global growth is firming, but it is hardly booming. Plenty of risks and uncertainties persist. But that doesn’t seem to be the way financial markets see it.
Last week the US VIX index – a widely watched index of market anxiety known as the “fear gauge” – dropped to its lowest level in 23 years. I doubt that policymakers and corporates feel quite that cheery.
PS - Last week the Economist reported on how the e-commerce boom is disrupting the US retail sector. 4,000 US stores closed last year and the retail sector has shed 50,000 jobs since January. Despite strong US consumer confidence and growth in retail spending S&P Global Ratings expects more US retailers to default in 2017 than in the recession of 2009. Having read the article I checked the equity market performance of the overall US retail index. I was surprised to discover that, in the last 10 years, the sector as a whole has outperformed a strong rally in the wider US equity market. While some department stores have suffered, other retailers, including TJ Maxx, Foot Locker and Children’s Place, have done very well. It provides a good example of how, even in sectors seeing profound disruptive change, there are winners.