Investment Committee is a new online series following on from its success in the magazine. We choose five heads of research, CIOs or senior directors from influential firms to form a panel of experts who give an insight into their firm's asset allocation meetings. Over a period of 10 weeks, each member writes two pieces.
Christian Holland of TAM Asset Management explains why cheap money is no substitute for sustainable earnings
At the start of 2015, we thought UK equities might have a fair chance of returning 6-7% despite a list of global issues to worry about as long as your arm.
At the time, as investors, we believed that if you could look through the various human tragedies and geopolitical upheaval, we told our clients that our main concerns for stock and bond markets were the risks that a strong US dollar could derail emerging markets and that continued inaction in the eurozone would fail to address a worse than expected fall in inflation.
However, we also said that a flood of cheap liquidity, as a result of ECB QE, would boost European stock markets despite weak economic news. Fast forward nearly four months, and we find that our forecast for the FTSE 100 index is already here and those investors with an overly cautious stance have missed out.
Obviously, some caution was understandable given that inflation has continued to fall further than most expected and that the US economy seems unable to accelerate beyond the 2% stall speed. Wage growth in the US and UK had also disappointed despite falling unemployment.
However, this has given the Federal Reserve and the Bank of England the excuse they needed to do what they were going to do anyway, which is nothing.
But while one might notionally expect low interest rates to be a real boon for the economy, the knotty problem is that corporations are not really that keen to borrow. Generally, a lot of company managements are more inclined to sit on large cash piles waiting for the economy to pick up before committing cash to hire new staff or invest for growth.
What companies in the developed economies have been doing is finding other uses for their cash piles by buying back their shares, raising dividends or even buying out their competitors through M&A.
It is here that equity returns are being boosted even as economic growth remains weak and UK earnings growth estimates for 2015 struggle to rise above 6-8%.
Looking at macroeconomic data here in the UK, we do ask ourselves if the consumer is unwittingly doing something similar.
With falling unemployment and signs that wages are starting a rise, one might have expected the economy to be powering away by now, but this is not what we are seeing. Indeed, UK retail sales fell further than expected in March. It’s true that this was, in part, down to a fall in petrol sales but, conversely, the fall in the price of oil should be undeniably good for the consumer.
The incentives for the consumer to save is almost non-existent given zero interest rates but what if they have decided that after half a dozen years of rising debt, which now stands at £10,000 per household (excluding mortgages), they’ve decided to start paying off debt, or stop accumulating it, despite a palpable sense that things are getting brighter? Perhaps the data will show up changes in behaviour after the election.
In the meantime, one gets the feeling that however much support stocks are getting from an abundance of cheap money, companies will have to deliver better sustainable earnings to support a stock market trading near all-time highs and not particularly cheap.
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