FTSE100 to finish year above 6000?
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There are good reasons for risk-asset investors to be positive towards equities generally, accepting that thin volumes imply a high chance of a sharp move in markets. Importantly a sharp move could now be up!
A positive view reflects the reality that whilst there are plenty of risks such as the German constitutional court decision, Spanish bank bail-out challenges, release of Troika funds to Greece, Spain may be or may be not signing a Memorandum of Understanding and applying for ESM funding, these are known unknowns and are manageable.
A key issue is that the ECB will be positioned to deliver once the ESM is approved, and this should be a game-changer, reducing the risk of messy Euroland break up.
The background is improving with economic news on the mend. We can see this from improving macro surprises with momentum stabilising, and it looks as if global GDP growth will stay well above 2% and could indeed turn out to be in the range of c3-3.5%, and this would compare with the average for the last three decades of 3.4%.
Meanwhile excess liquidity, the amount of free cash in the economy, continues to rise at an annualised rate of c.5% which supports a material re-rating of risk assets. This progress is further supported by the strong likelihood of US QE 3 (the third salvo of Quantitative Easing by the Federal Reserve) by year end. What’s more, synchronised QE in the G4 economies by end Q1 2013 still looks probable and this should support both economies and markets.
The case for equities is helped by valuations that remain supportive. The forward looking equity risk premium is 6.3% and the current picture of credit spreads and economic surveys suggests that it should be 5.5%. We will write in more detail on this, but for now we can note that it is also helpful that the corporate earnings yield remains above the junk bond yield.
As for risks to different assets, we believe long-term inflation expectations will continue to rise as central banks ‘print money’. Importantly this supports equities until inflation expectations rise above 4%, which looks to be a low risk, at least for now.
There are also shorter term sources of support from tactical indicators. Risk appetite indicators remain depressed, and positioning by hedge funds is still cautious. This is the sort of environment which lead to a short squeeze. Certainly many investors expect risk asset markets to correct lower in September, and this reduces the actual risk of a correction ever taking place simply because many investors are already positioned for bad news.
As for corporate news flow, the data and news flow show that the rate of earnings downgrades are stabilising and ordinarily this should be construed as a good sign.
Some caution is appropriate however – consensus expectations of sell side analysts still look extravagant, suggesting that there are plenty of risks of disappointment at the individual stock level, but that said the FTSE 100 could well finish this year above 6000 and still have room to move forward on a sustainable basis through 2013.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
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The Local Authority Treasurers’ Investment Forum September 25th, 2012, London Stock Exchange
