Last updated: 16:35 / Tuesday, 15 July 2014
Opinion by Henderson

The Eye of the Beholder

The Eye of the Beholder

2014 marks the 450th anniversary of Shakespeare’s birth. In one of his early comedies, Love’s Labour’s Lost, the bard wrote that “beauty is bought by judgement of the eye”, which seems a very fitting comment for current market conditions: we are at a point in the economic and market cycle where perceptions and starting points are very important.

For one thing, US equities have reached an all-time high, having nearly tripled in value since the market’s post-crisis low in March 2009. After a very strong performance in 2013, many investors are banking profits and looking for reasons to sell. Under these circumstances it must be questioned whether good economic news is genuinely ‘good’ or in fact ‘bad’, because it portends monetary policy tightening. Economic conditions are far from homogenous globally and with so much central bank intervention having occurred (US), still occurring (Japan), and indeed likely to occur (eurozone), there appears to be a natural growing distrust of the current equity bull market. Most importantly, market volatility is at very low levels and is ‘spooking’ investors. Thus, we are at an interesting, if not perplexing, juncture for the global economy and more pressingly for global markets.

Fair is foul…

After the first quarter’s weather-induced slowdown in North America, current economic data points to an aggressive snap-back in the underlying US economy. Certainly we see nothing to temper the desire of North American policy makers to begin the process of normalising interest rates once quantitative easing has ceased. The picture is more complicated in Continental Europe, with purchasing managers’ indices generally favourable, albeit with weakening momentum. Moreover, with the euro elevated beyond the level that the European Central Bank considers optimal and with inflation soft, the threat of unconventional monetary policy, just as the Federal Reserve scales back its policy, is intriguing and potentially very helpful. Is, however, Europe’s tepid economic position really ‘good’ news because it means more policy stimulus? Or is it just outright worrying that despite the tumultuous declines in output, that demand remains so lacklustre? For bottom up stock specific investors, finding idiosyncratic mis-valued stocks has never been more important.

…Foul is fair

If the balance between policy and growth in the Western world seems finely poised then consider the East, especially China and Japan. The latter seems to have weathered the April consumption tax rise well – so well in fact that further economic stimulus in the shape of QE seems an unlikely prospect in the near term. In the space of the past three months, investors have moved from seeing this as ‘bad’ news to instead seeing it as ‘good’ news. Prime Minister Abe seems to be fleshing out the details of his third arrow of economic stimulus and with the potential for the world’s largest pension fund (Japan’s Government Pension Investment Fund) to materially add to its equities weightings, the prospects for the Japanese economy are certainly on an improving trajectory. The potential for it and indeed the wider global economy to be derailed by a significant slowdown in China remains a key danger, however. Targeted stimulus appears to be positively impacting the Chinese economy, but concerns remain that larger structural challenges abound and risks are elevated.

Infinite riches

Certainly, in the interim, corporate cash is starting to be deployed. The long-awaited turn in the capital expenditure (capex) cycle is still struggling to gain momentum, but while companies seem reluctant to build they seem much more willing to buy. With cash balances swelling and the cost of money still so cheap, we have witnessed a wave of corporate activity during the second quarter. This has occurred across a variety of sectors and very often involving US companies seeking to either utilise their stranded overseas cash or indeed more aggressively ‘invert’ their underlying tax jurisdiction, which helps increase the efficiency of their capital structures. With investors generally greeting such deals favourably – the share prices of acquiring companies have typically risen – the cost of money remaining low, and economic conditions on balance remaining satisfactory, we would expect more such deals in the second half of 2014.

In this update Matthew Beesley, Head of Global Equities at Henderson Global Investors, gives a brief recap on events in 2014 and his outlook for markets for the second half of the year.