THE MARKET roller coaster of recent months may have been unnerving for all investors, but the good news is that volatility is now back in line with long-term averages and market behaviour has normalised.
We believe investors should not be put off by these gyrations.
The current consensus forecasts for economic growth in 2019 are 1.5 per cent for the UK and Europe, 2.5% for the US and 0.9% for Japan, while the Chinese economy should see real growth of 6.2%.
In comparison the outlook for US and Japanese growth in 2020 is weaker while broader European growth should remain constant.
The price/earnings ratio on global equities, based on next year’s projected earnings is 11% below the 20-year average, while earnings themselves are projected to grow around 5%.
So, while the world economy may be cooling, it remains warm and equity ratings are far from demanding.
The cheapest equity block is the UK, where ratings are nearly 20% below long-term averages and where the media reminds us on a daily basis why that discount is required.
Elsewhere, valuations appear to be reasonable, but there are many banana skins which investors will find it difficult to avoid slipping up on.
The US Federal Reserve may look less like a bogeyman than it did a few months ago – and some judge its work here is done - but we should remember the US economy has a habit of starting the year slowly before gathering pace thereafter (what then of the ‘Fed pause’)?
Then there is China, eurozone fiscal policy, the wasting-away of Abe-nomics in Japan and, of course, the myriad populist challenges led by President Trump’s perhaps increasingly desperate (should that be disparate?) agenda.
If the risk/reward outlook for equities looks balanced, the same isn’t true for UK government bonds, otherwise known as gilts.
I’m not the first to suggest gilt yields are on the turn - the forecasters graveyard overflows with my predecessors, this is my first go.
The issue is not that, at 1.25%, yields are too low – these can be rationalised. It’s more that the forces that drove yields here look tired.
Notwithstanding the steady flow of reports of the demise of the high street and, of course Brexit, the resilience of the UK economy has been noteworthy.
It’s clear that, but for Brexit, UK base rates would be higher than their current level of 0.75% and hikes would quickly put (upward) pressure on longer-dated yields.
Looking at those that have been buying gilts, things look on the turn.
Money has flooded in from Europe with enough cash recycled from the European Central Bank’s now-ceased quantitative easing programme to fund one-third of the UK’s yawning trade deficit.
At home, while pension funds may remain ongoing buyers, the gilts feeding frenzy has peaked.
Meanwhile, the UK Government has embarked on a Trump-style process of fiscal relaxation so, absent a bad Brexit, the UK will find it has a higher cost of capital.
But what if we get a bad Brexit? The pan-European economy will take a knock led by a UK slowdown - something gilts always enjoy.
The domino effects should, however, quickly prove very challenging.
The political blame-game will go into over-drive with an early general election a strong prospect.
The last one dispelled the notion that Labour was unelectable; protest votes never go well for the incumbent administration.
A Labour government led by Jeremy Corbyn would herald a monumental regime shift in UK fiscal policy, which global investors are bound to want to watch develop from the sidelines.
Don’t expect that eurozone money to hang around – especially if sterling is tanking at the same time, as many expect.
For the moment gilts have merit as a Brexit disaster hedge. But Brexit could prove to be a disaster for gilts whichever way it plays out.
Stephen Jones is chief investment officer at Kames Capital.
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