Global Investing

Steroids, punch bowls and the music still playing: stocks dance into 2014

November 21, 2013

Four years into the stock market party fueled by a punch bowl overflowing with trillions of dollars of central bank liquidity, you’d think a hangover might be looming.

But almost all of the fund managers attending the London leg of the Reuters Global Investment Summit this week – with some $4 trillion of assets under management – say the party will continue into 2014.

Pascal Blanque, chief investment officer at Amundi Asset Management with over $1 trillion of assets under management, reckons markets are in a “sweet spot … largely on steroids with the backing of the central banks.”

If their collective benign world view pans out, the S&P 500 will comfortably post double-digit gains next year.

This despite having already tripled in just four years and chalked up a near 30-percent gain this year – its best year in a decade – to hit a record high above 1800 points. It’s been 18 months since the index chalked up a 10 percent correction.

The summit’s bullish consensus was overwhelming, if lacking last year’s gung-ho conviction. None of them showed any concern that the entire industry appeared to be on the same side of the trade (although calling it a “trade” could be a misnomer if there’s no one on the other side).

But there are reasons to be extremely cautious: market fatigue; tighter U.S. monetary conditions via rising Treasury yields (4% or higher?) and Fed taper; sclerotic growth, an impaired banking system and threat of deflation in Europe; and weak and fragile emerging markets.

Trumping all that, however, will be less of a fiscal drag in the United States, an ongoing housing recovery, pent-up capital expenditure on both sides of the Atlantic and continued corporate profitability.

Cynics might point out that the tidal wave of capex was meant to break this year, and the year before that, and the year before that. If companies were too afraid to invest in the midst of unprecedented central bank stimulus, record low borrowing costs and runaway asset markets, will they be so ready to splurge now?

Valuations may be stretched. The St. Louis Fed notes that corporate profits as a share of GDP is the highest since the 1930s just before the crash, and the chart below shows them at record levels in nominal terms. Can they rise further with a domestic economy growing less than 3 percent and a global economy growing less than 4 percent, as per OECD forecasts?

 

 

There’s also an “ugly contest” element at play here. Equities could continue to rise simply because it’s the least unappealing asset class in an otherwise grim-looking world for investment returns. Emerging markets are far too fragile, the return on bonds barely beats inflation, and cash yields even less.

But sustainable corporate revenue and earnings growth will require a sustainable and broad-based rise in consumer spending, which in turn hinges on a sustainable and broad-based improvement in the labor market. As U.S. bond investor and fund manager Robert Kessler points out (his red pen), this is a long way off:

“The percentage of people working needs to rise in order for aggregate income to rise, which leads to higher spending, which leads to higher GDP, and leads finally to inflationary pressures,” Kessler says.

But the $4 trillion men don’t see that as an issue for next year.

“The show will go on, with the help from all our friends at the central banks,” said Amundi’s Blanque, echoing former Citigroup chief Chuck Prince’s ill-timed quote in July 2007 as the housing and credit and bubbles were just about to burst with catastrophic effect.

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