Signs are pointing to revival

Apr 14 2010 by Andrew Miller, The Journal

IN OUR view, the macro-economic debate feels as if it has shifted significantly over the last week. No single news item has been responsible for this shift.

Rather, a steady accumulation of data releases and corporate anecdotes has made it difficult to argue against the idea that a meaningful and widespread revival in economic activity is under way.

Specifically, US order books have strengthened, at above-trend levels; re-stocking (as opposed to slower de-stocking) is also under way; and, perhaps most encouragingly, US employment looks to be stabilising. Retailers report resumed growth in discretionary spending, and the official data show total US household outlays to have more than made good the recession’s damage, even as the volume of outstanding consumer credit has been shrinking steadily. Meanwhile, China’s slowdown looks less convincing than it was, and even Eurozone and UK businesses are reporting marked improvements in their prospects.

This is of course no guarantee that the latest gains in stock, credit and commodity prices will be sustained. Markets look forward, and often the excitement, as the cliché goes, is in travelling rather than arriving. Meanwhile, sovereign debt worries continue to rumble on in the background and are unlikely to go away in the short term. In any case, even if sovereign debt markets do shake off their worries about the parlous state of many governments’ finances, interest rates must at some stage normalise, which – all else equal – would provide a headwind for government bonds.

But while we are aware of the risks, we think the rallies in risk assets are solidly based, and would advise investors to use the inevitable short-term market setbacks to diversify further out of cash and into equities in particular.

Some improvement in equities’ performance is arguably long overdue after their awful performance in recent years (though this is of course no guarantee that it will actually happen). However, even with a more encouraging macro-economic picture, investors’ expectations of stock markets remain very low. Just how low expectations have fallen in some cases was brought home to us in an investor meeting in the US last week.

Of the assets that this specific investor held in his portfolio, the best-performing over the last decade had been US TIPS (inflation-proofed US government bonds) – despite inflation itself having been subdued, and most of his investment advisers having recommended stocks over bonds. Looking ahead now, he asked us, why shouldn’t the same thing happen again?

We argued that the last decade – the “noughties” – was pretty special. It ended with US GDP growth trending at a 50-year low, with the corporate sector in loss and with interest rates at equally extreme levels. We also noted that it began with stocks looking egregiously expensive amidst the folly of the technology, media and telecoms “bubble”, which, of course, burst in extremely spectacular fashion in 2002.

But all this was to no avail – providing us with another reminder that the credibility of some long-established financial wisdom may have suffered more lasting damage of late than has the fabric of global business.

Andrew Miller is manager of the Newcastle office of Barclays Wealth