Are double dippers right to worry?
RISK assets - equities, credit and commodities - rallied strongly in July. However, we doubt that investor expectations are yet ready to settle definitively in favour of one of the bipolar outcomes - either a stock market boom or a deflationary bust - with which they've been preoccupied these last few months.
Retaining some insurance against a renewed resurgence in deflation nerves thus seems sensible to us. Last week’s US employment data again illustrated the tentative nature of the revival in labour demand, and follow hot on the heels of news of an unexpectedly marked slowing in US GDP in the second quarter. The double dippers – those who believe that the economy could yet turn down again – are not going away any time soon.
However, the bounce in risk assets is a reminder of how far some valuations had already fallen, and of the fact that not all the macro-economic news is pointing downwards.
Last week’s business surveys from the developed world, for example, seem to suggest that the third quarter of 2010 may not be quite as fragile as feared, even in the battered eurozone. Additionally, it is important not to forget that the second quarter US GDP slowdown followed an upwardly-revised first quarter, and revealed the US capital spending boom to have been quietly gathering momentum.
Meanwhile, in much of the emerging world – and in the UK – inflation risk is far from moribund, and the bottom-up news from US and European companies continues mostly to surprise positively.
On the latter front, much of that news has been viewed as being of poor quality because it has largely reflected lower provisioning by the banking sector.
This is neither the time nor the place to tackle this view more carefully, but we note that if previous asset write-downs were in some cases excessive, then the quality of some recent and pending good news here may not be much lower than that of the bad news which preceded it. This may serve as a reminder, perhaps, that not all market risks are negative ones.
Of the two halves of the “barbell” tactic we’ve been advocating – long-dated government bonds, plus exposure to equities and high-yield credit – the long-term valuation case looks strongest for developed equities.
However, for the time being, both positions have been working: as equities have rallied, Treasury yields have stayed low, and both assets have managed to outperform cash (admittedly, only just in the case of bonds).
As we’ve pointed out in this column before, it is, in fact, not that unusual for returns to follow this pattern – in the 1980s and much of the 1990s it was indeed the norm, not the exception, fostered by a combination of sustained disinflation alongside solid growth in profitability.
The difference this time, we thought, was that investors’ “bimodal” expectations made it more likely that only one of the positions would be responsible for any gains – an either/or outturn.
With the number of both buyers and sellers likely to remain low over the remainder of the summer, that may yet turn out to be the case.
:: Andrew Miller is regional office head of Barclays Wealth