Best-kept secret coming out of America

Mar 17 2010 by Andrew Miller, The Journal

RISK appetite seems to be stabilising again. Stocks, commodities and corporate credit are at the top of their recent trading ranges; government bonds and the VIX - Wall Street's so-called fear index - have been close to the bottom of theirs.

Recent data show that money continues to flow out of safe-haven US money market funds. Perhaps more importantly, Greece, after a torrid few months, is slowly beginning to disappear from the front-page headlines.

However, despite these positives, risk assets are surely not out of the woods just yet. Fears of a US double dip, for example, will likely resurface with each wobble in the data. Even if growth remains positive (as we expect), we still have the potentially painful process of interest rate normalisation ahead of us.

Fiscal policy too has to be tightened, particularly in the developed world, where the cost of fighting the financial crisis has been very high; we have yet to see the details of financial re-regulation and geopolitical risk continues to simmer quietly, with Iran in particular serving to remind investors that there are plenty of non-economic risks to think about. And, just for good measure, we know that not everybody shares our positive view on (for example) equity valuations.

Often, however, a wall of worry is there to be climbed – it can be telling us that a lot of bad news is implicitly in the price, and that potential good news is perhaps being overlooked. Each month in which growth remains positive, and yield curves almost vertical, is another month in which corporate and bank balance sheets grow stronger.

The best-kept secret in the markets, in our view, is the dramatic surge in US private- sector cash flow that is the mirror image of the much more visible deterioration in government finances. Another item that received less attention than it deserved, perhaps, was the news that China’s exports are up strongly and by more than imports.

If China is exporting so quickly, then domestic demand somewhere else has to be growing reasonably – in contrast to the media and markets’ somewhat lazy assumption that global growth these days is a one-trick Chinese pony. (In reality, of course, the US consumer is still the number one customer for Global Inc, and last Friday’s retail sales data confirm again that US consumers are indeed continuing to spend, supported no doubt by bumper cash flow.)

And sometimes a known risk can simply prove less daunting in reality than it appeared in prospect: context is everything. This is why so many stock market rallies in the past have continued well beyond the first rise in interest rates.

We have favoured stocks and corporate credit ahead of government bonds and cash so far in 2010 (indeed, this has been our stance since last autumn). So, for now, we continue to recommend that investors remain invested in stock markets, with a bias towards developed world equities.

Andrew Miller is regional office head of Barclays Wealth