It has been a frustrating year, with the UK market range-bound and few opportunities for delivering significant portfolio returns.
Performance of index in 2014
Source: FE Analytics
Surveys of investor sentiment showing large numbers of ‘neutral’ readings speak volumes about the ennui and indifference in equity markets. Low trading volumes echo the story.
‘Invested, but unenthusiastic, with the traditionally difficult October to navigate and little to look forward to’ seems to sum it up. No one thinks equities are cheap.
Cheap relative to other asset classes, or fair value, is the most supporters are prepared to claim, whilst for the bears valuations are already extremely expensive, riding on a tide of central bank liquidity far removed from the reality of sluggish global growth, pedestrian profits progression, record profit margins and unprecedented debt levels.
So – in the spirit of the changing seasons – what can we worry about this autumn?
First, if the Fed sticks to its tapering timetable then QE in the US will come to an end, thereby removing the primary liquidity driver of equities, according to the bears.
For some, rising bond yields will undermine the key valuation support for equities – and if yields rise sufficiently, may prompt pension fund switching from equities into bonds.
For others, the Fed is already behind the curve, the US inflation genie is out of the bottle and merely taking a while to register meaningfully in the data. When it does, dragging yields and Fed funds materially higher, equities can hardly emerge unscathed.
A counter-worry is that recent PMI surveys the world over suggest another ‘growth scare’ is imminent, as activity rolls over.
What can the central banks do for an encore to stimulate more? Surely not QE4?
QE in Japan has succeeded in weakening the Yen, if not yet engendering sustainable growth, but the impact on Europe’s exporters is at least part of the reason why Europe has ground to a halt.
European bond yields suggest that the continent is embarking on a multi-year Japanese deflationary experience. Expectations ride high for a European QE, even before their banks’ Asset Quality Review and the start of the ECB’s next round of cheap bank funding, designed to stimulate credit growth.
But if European equities expect to be saved by the ECB’s kick-starting of growth, then at the very least one has to note that the scope for disappointment against expectations from the ECB is hardly without precedent.
Bond and equity price levels cannot both be right over the long-term.
More immediately, any impact from loosening of monetary or indeed fiscal policy in Europe – the latter appears to be a politically acceptable discussion point once more – will almost inevitably be slower than the impact today on European economic activity of the escalation of tensions, sanctions and trade barriers between Europe and Russia.
No Russian gas in Europe this winter, anyone?
US airstrikes on the IS insurgents have taken the situation in Syria and Iraq off the very front pages most days, but the situation is far from being resolved. Libyan oil exports – a key marginal supply – stop and start erratically. An oil price spike in the northern hemisphere’s winter cannot be ruled out.
It is no surprise to see relations between China and Russia warming as the West tries to isolate Mr Putin. More surprising are events in China, where the new leadership appears to have broken the taboo that it never threatens previous leaders or their protégés.
The anti-corruption drive is claiming bigger ‘tigers’ as well as ‘flies’, whilst neatly dovetailing with the anti-smog pro-green attacks from Beijing on major domestic players in oil and coal.
As a result it is hard to establish whether some of the mixed signals emerging from some of China’s basic industries reflect the impact of these policy initiatives or genuine weakness in end demand.
For the bears, of course, current weakness in property prices is merely the beginning of the inevitable bust, alongside the implosion of the shadow banks which have funded it.
Then of course, without being too alarmist, one has to keep a wary eye on the Ebola breakout in Africa.
So long its incubation period in innocent travellers, it could easily appear in our inter-connected world on other continents, with potentially frightening consequences for business and consumer confidence, travel, trade and activity.
And – my personal favourite – supposing any one of these fears leads investors to seek en masse the safety of cash.
Exchange traded funds, in my view, can provide the illusion of daily liquidity in indices and asset classes where the underlying liquidity has yet to really be tested in a panic. Suspension of dealing or exit restrictions could reinforce any sense of alarm and become self-fuelling: as witnessed so often, dangers lurk at least as much within financial market structures as in the real economy.
Meanwhile, after a well-earned summer break, the bankers, brokers and advisers are gearing up for a three month window to IPO a swathe more companies before closing the books for year-end.
High quality companies with strong balance sheets, good management and attractive valuations will abound, I have no doubt.
So, many things to worry about. And markets climb a wall of worries.
Richard Buxton (pictured top of page one) is manager of the £1.5bn Old Mutual UK Alpha fund, having previously run the Schroder UK Alpha Plus fund.
According to FE Analytics, his Old Mutual fund has been a top quartile performer in the IMA UK All Companies sector since he took over in December 2009, with returns of 82.14 per cent, beating the FTSE All Share by close to 25 percentage points.
Performance of fund vs sector and index since Dec 2009
Source: FE Analytics
Old Mutual UK Alpha has an ongoing charges figure (OCF) of 0.78 per cent.
