Stock markets have held up well in the face of global economic turbulence. But a US debt default could change all that, says Stokesley stockbroker Andrew Priestley.

SEVEN months into 2011 and the UK stock market has failed to hold ground above its January 4 intraday high of 6043 on the FTSE100.

The index has since traded in a relatively narrow range of around 300 points, supported at 5700 on several occasions.

Some observers may be surprised that investor confidence has remained intact when faced with unspectacular economic data, the Japanese quake and tsunami, the Greek/ Portuguese debt bail-out and of most immediate concern, the prospect of a default by the US in the absence of an agreement on a higher debt “ceiling”, currently set at $14.3 trillions.

In layman’s speak, to lift that ceiling would equate to an increase in the country’s overdraft limit.

Without it, the US government would no longer be able to pay the monthly Social Security cheques, as well as financial assistance to the elderly, the unemployed, Medicare and Medicaid or to honour the thousands of contracts with multinational companies.

While it is likely that political brinkmanship will yield to expedience and commonsense, the US will be in no better position to repay its debts if this hurdle is crossed unless it takes a knife to its budgets and spending plans and initiates the austerity programmes reluctantly embraced by other developed economies in the west.

This is the message that Republicans and The Tea Party are hammering home by their dogged refusal to accede. But if they don't reach a compromise, expect global markets to force their hand.

The dire consequences of a default and lowering of the credit rating of the world’s largest economy and reserve currency aren’t hard to fathom. One major fund manager deemed the prospect “absolute madness”.

Expect China, which holds three trillions of dollar foreign reserves, to be somewhat under-whelmed!

And with so many loans collateralised against US Treasury paper, a global systemic financial shock would seem unavoidable.

Yet in spite of this possibility, investors are still chasing good quality company shares, particularly those with generous and growing dividends and those exposed to the burgeoning growth of China, India, Brazil and the emerging economies whose consumers account for well over half the world’s population.

As domestic growth falters, so the likelihood of further stimulus will increase and any rise in interest rates will move even further down the road.

With inflation stubbornly high at around 5%, returns on cash savings are negative in real terms.

Perhaps that is why, despite the risks and volatility associated with equities, they remain the asset class of choice at present.

Put it this way, the yield to maturity on a UK Government Gilt Edged stock repaid in 2014 is just 0.6%. The annual dividend on many of the FTSE100 company shares is between five and ten times that return.

And if you favour looking further afield, there are solid Scandinavian banks and Swiss pharmaceutical giants with 5% yields.

Stock markets have trended sideways all year trying to strike a balance between risk and reward, often climbing a wall of worry.

The scope for a major disappointment or indeed a huge sigh of relief is ever present.

What is certain is that just like Alice from the Mad Hatters Tea Party, many of us are finding it all “curiouser and curiouser”.

Andrew Priestley is a stockbroker at Redmayne-Bentley which has an office in Stokesley.