Just a month into 2013 and so many of the worries of 2012 seem a distant memory. It was just six months ago that the head of the European Central Bank, Mario Draghi, had to pledge to do “whatever it takes” to prevent a meltdown of confidence in Europe.
The perpetual worry about a double-dip recession once again did not come to pass. Even the US fiscal cliff passed with a classic Congressional “deal”, reminding us of Churchill’s dictum that “you can always rely on Americans to do the right thing… after they have exhausted all the other possibilities”.
After seeing America troubled for so long, suddenly there is a lot to be positive about. British Petroleum last month predicted that the US would be virtually energy independent by 2030, something once considered unthinkable.
A moribund housing market, having dropped several trillion dollars in value since 2007, is now turning around and could start adding trillions to the wealth of ordinary Americans once again, thus bolstering consumption. Even in manufacturing more reports of “re-shoring” emerge as soaring Chinese wages make many companies look at the benefits of manufacturing in America once again.
Political considerations
Investors these days have to worry about political volatility as much as market volatility. It is noteworthy that not only have both sides of US politics reached a deal on the fiscal cliff and allowed time to have a more civilised debate on spending cuts, but also on issues as intractable as immigration reform. There is now some bipartisanship raising the tantalising prospect of making 11 million longstanding but illegal residents citizens at last – and importantly, taxpayers.
In China, signs of a real economic recovery continue to strengthen as industrial production, electricity demand and higher retail sales all recover from recent lows.
The handover of power to a new generation of leaders is completed next month and should end an extended period of inertia. Highly publicised visits to rural areas and a new plan to boost minimum wages indicate that new president, Xi Jinping, is determined to raise incomes to make domestic consumption a more important driver of the economy.
China’s spat with Japan over the uninhabited and rocky islands of Senkaku has not been enough to dampen renewed investor enthusiasm for the new government’s very determined efforts to end two decades of deflation in the land of the rising sun. Indeed, it looks increasingly likely to take the form of massive take-no-prisoners money printing that Japan has been more hesitant to embrace compared with the US and Europe.
And while Europe faces a long road back to recovery, perhaps in much the same way Germany reformed itself a decade ago, at least it is no longer giving markets heartburn on a weekly basis.
Technically bull territory
All together, it’s a pretty robust picture and partly explains why equity markets have had such a strong start to the year as risks have receded across the globe. Even in Australia, where business sentiment is weighed down by the combined impact of a high dollar, lower commodity prices and fiscal austerity, stocks have technically entered bull-market territory.
It provides a timely reminder that equities bottom and start rising ahead of the real economy as they anticipate better times ahead. The market never rings the bell indicating that it is safe to jump on board. Investors will also need to keep a careful eye on the other end of the investment spectrum. While fearful investors sent share-market valuations to record low levels in recent times, they also pushed Australian bond prices to record highs. This is reflected in paltry bond yields at multi-decade lows, which are barely ahead of the rate of inflation (and even below dividend yields of the share market).
Investors will always need to make a balanced assessment of their personal needs and risk appetites, but as they contemplate global recovery, lower interest rates and the future need for income alongside some capital growth, it is likely they will also have to reassess whether the risk of being out of markets once again exceeds the risks of being in.
For those looking for higher income and less volatility, equity income funds offer clients not only the potential for higher income from equities and the ability to participate in market rallies, but also some downside protection too.
James Holt is an investment specialist at Zurich Investments
