Asset prices in The Monday Briefing
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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.
Western politics has developed a more nationalist character in recent years. In Europe populist parties claim to champion national interest against globalisation while in the US Bernie Sanders and Donald Trump have broken with the free trade consensus that has lasted since 1945.
Slow productivity growth is one of the biggest topics shaping current economic discourse.
It is hard to overstate the importance of productivity in driving improvements in living standards. Since 1850, UK GDP per head has risen 20-fold, transforming our standards of living. If productivity had remained flat over that period, GDP per head would only have doubled.
UK labour productivity rose at around 2% a year from the seventies but has stagnated since the financial crisis. British productivity now remains only slightly higher than its pre-crisis peak at the end of 2007.
The last Deloitte survey of UK Chief Financial Officers shows a further easing of the Brexit shock that hit corporate spirits last summer. The full report is available at:
CFO perceptions of external macro-economic and financial uncertainty have almost halved since last year’s EU referendum. Business optimism, which dropped to the lowest level in nine years last July, has risen to an 18-month high.
It is perhaps odd that despite gloomy news stories about the risks to growth the world economy is recovering. And this is a rare thing, a synchronised global recovery with activity strengthening in developed and emerging markets for the first time since 2010.
Leading indicators for growth are flashing green. Singaporean export growth, a barometer of global demand, has hit a two-year high. Chinese electricity consumption has rebounded.
The Governor of the Bank of England, Mark Carney, recently lamented Britain’s “first lost decade” since “Karl Marx was scribbling in the British Library” in the 1860s. He was referring to the fact that wage growth for the average British worker has stagnated in the decade since the financial crisis.
Last year earnings for the median worker in the UK, the person in the middle of the wage distribution, were almost 7% below their pre-recession level in real terms. The latest official forecast shows that real earnings are unlikely to return to pre-recession levels until 2021.
Free trade helped power a dramatic rise in living standards in the West in the nineteenth and twentieth centuries. In the last three decades it has had a similar impact on the welfare of billions of people in emerging economies.
Yet in the face of a backlash against globalisation, free trade is arguably more at risk than at any time since the 1930s. Those who want to limit trade see it as a way of “bringing home” high-quality jobs and reinvigorating industry.
Switch on the TV news, follow Twitter or read a paper and it can feel like we are living in an era of high, perhaps unprecedented, uncertainty.
We certainly seem, over time, to have become more aware of uncertainty. Since the 1940s references in English language books to uncertainty, volatility, complexity and ambiguity have soared. The term Chief Risk Officer did not exist before the mid-1990s. Now CROs are an established part of many large companies. In the 1990s the US army War College coined the term VUCA in to describe an apparently new world of volatility, uncertainty, complexity and ambiguity.
The performance of financial markets provides signals about the state of the global economy. Market movements in part reflect shifting expectations about growth, inflation and risk. The messages from markets are fallible. But unlike economists’ forecasts, the positions investors take are backed by real money.
So who made money in financial markets in 2016 and what does it imply for the global economy?
The global recovery is entering its eighth year – sufficiently long for some commentators to suggest that we are due for another recession. That seems premature. 2017 looks likely to be another year of growth for the global economy, and at a rather faster rate than in 2016.
But this is not likely to be the year in which growth finally breaks through, returning to the heady rates seen in the decade before the financial crisis. In other words, activity is likely to remain close to the lower, so-called New Normal levels seen since 2009.