“TRICK or Treat?” was the question from the children in my neighbourhood on Halloween night. Judging by the sweet-stocked pockets - buckets in some cases - on display, treat was the only answer they wanted, with trick viewed as wildly uninteresting. I didn’t disappoint.
Financial markets have enjoyed a much better Halloween period than last year, when stocks had their worst October since the 2008 financial crisis, but are now sending two very distinct and very conflicting messages. Bond markets are pointing towards recession, while equity markets reflect mass optimism, with the US market just this week clocking a fresh record high. Our belief is that the reality lies somewhere in the middle.
Bond markets are notoriously pessimistic; the mathematical way in which they’re priced shackles any over-exuberance. That said, they’ve gone from having a glass that was always half empty to one that is, well, just empty. Bond yields touched record lows in early September and are still knocking around those levels. This is captured by a bizarre reality where we have huge amounts of debt that trade with a negative yield.
Effectively, this is financial markets saying that if you’ve run out of room under the mattress then you can lend your money to high-quality governments instead, but - and here comes the catch - you have to pay for the privilege.
While this may seem totally far-fetched, investors are falling over themselves to do just this: we chalked up an eye-watering level of $17 trillion worth of debt at the end of August. This has now dropped down to a mere $13trn but it still sounds a very gloomy message from the bond markets.
Equity markets, on the other hand, are full of cheer: the glass is half full and what is inside tastes good. We’ve seen bumper returns across all geographies this year, with record highs being achieved by the world’s biggest market, the US.
These returns, which range anywhere from 10 per cent to 20%, have come in the face of slowing economic growth and faltering corporate profitability. The cry from the equity markets is that central bankers will save the day and that growth will reignite to spur on corporate profitability. They may be proved right, but our view is their enthusiasm has run too hot.
Economic data has been pretty dire this year. Manufacturing data has trended downwards from low levels and the sector is now firmly in recession. Granted, manufacturing is a smaller piece of the pie than it once was - about 10% of developed market growth - but it still matters. A persistent slowdown in this sector can feed into lower levels of investment, lower levels of profitability and lower levels of confidence. For now, the all-important consumer looks robust. Yet despite consumers finally reaping the benefits of multi-year levels of low unemployment, it’s a delicate balance.
Corporate earnings have been pretty poor this year, with the only consolation being that they have been better than expected; a small jump over an already low bar. Equity markets are looking forward to next year – and herein lies their enthusiasm – where expectations are for double-digit earnings growth. This is predicated on a rebound in economic growth from market friendly central bankers. We remain to be convinced.
Experience has shown us that markets tend to overreact. The trick won’t likely be as ghastly as that offered by the bond market, nor the treat as sumptuous as that promised by the equity market. However, it’s not as simple for central banks as just handing out sweets, which would mean cutting rates and printing money. They’ve done this exhaustively over the last 10 years to the point where the incremental gain becomes less and less. As such we’ve used the strong market performance to do some tactical rebalancing across our clients’ portfolios and will curb our enthusiasm until we see companies starting to grow their earnings once again.
Tim Wishart is head of Scotland and the North of England at Psigma Investment Management.
Why are you making commenting on The Herald only available to subscribers?
It should have been a safe space for informed debate, somewhere for readers to discuss issues around the biggest stories of the day, but all too often the below the line comments on most websites have become bogged down by off-topic discussions and abuse.
heraldscotland.com is tackling this problem by allowing only subscribers to comment.
We are doing this to improve the experience for our loyal readers and we believe it will reduce the ability of trolls and troublemakers, who occasionally find their way onto our site, to abuse our journalists and readers. We also hope it will help the comments section fulfil its promise as a part of Scotland's conversation with itself.
We are lucky at The Herald. We are read by an informed, educated readership who can add their knowledge and insights to our stories.
That is invaluable.
We are making the subscriber-only change to support our valued readers, who tell us they don't want the site cluttered up with irrelevant comments, untruths and abuse.
In the past, the journalist’s job was to collect and distribute information to the audience. Technology means that readers can shape a discussion. We look forward to hearing from you on heraldscotland.com
Comments & Moderation
Readers’ comments: You are personally liable for the content of any comments you upload to this website, so please act responsibly. We do not pre-moderate or monitor readers’ comments appearing on our websites, but we do post-moderate in response to complaints we receive or otherwise when a potential problem comes to our attention. You can make a complaint by using the ‘report this post’ link . We may then apply our discretion under the user terms to amend or delete comments.
Post moderation is undertaken full-time 9am-6pm on weekdays, and on a part-time basis outwith those hours.
Read the rules here