HAMISH MCRAE: Slowly, market trust is returning and investment community may be starting to look beyond recession valley to uplands on other side
Here’s a puzzle. The Bank of England did its best to frighten us all on Thursday, upping its rates by the expected 0.75 per cent to 3 per cent, and warning of the longest recession for a century next year.
And we have been warned the autumn statement on November 17 will clobber us with higher taxes and spending cuts. So how come the FTSE100 index ended up more than 4 per cent on the week, with Friday one of the best days shares have had all year?
Confidence: The investment community may be starting to look beyond the recession valley to the uplands on the other side
The best explanation comes in three parts. First, investors around the world have regained their confidence that the main central banks really mean what they say about their determination to crush inflation.
True, two members of the monetary policy committee voted for a smaller increase in rates, but that is a result of their inexperience of how markets react when they think the central banks have gone soft on inflation.
Both the Federal Reserve and, a week earlier, the European Central Bank met market expectations with 0.75 per cent increases in rates, with promises of more to come. This is a global thing. The world’s central banks know they made a huge error with ultra-easy monetary policies of the past decade and have to correct it now.
This renewed confidence helped the Bank of England make an important first step last week in unwinding quantitative easing, by selling back to the market £750million of the gilts it had bought under the QE programme.
The auction was oversubscribed more than three times. That says there is plenty of demand for the UK Government’s debt. Trust is returning, with the markets believing that the Sunak/Hunt alliance will get the country’s finances back under control. The second part of the explanation is that investors are beginning to position themselves for the next expansion. We all know there is a global economic cycle, of very roughly ten years’ duration.
The world economy is clearly heading into a downturn, which may be quite a long one. The Bank of England thinks it will be long but not particularly deep for the UK, and they may be right. But there will be an upturn to the cycle and since they only come once a decade, you don’t want to miss it. Share markets are lead indicators of economic expansions.
Think of it like this. You want to catch a bus that comes roughly once every hour, but sometimes is up to ten minutes early and sometimes ten minutes late. Much better to show up 15 minutes early, even if it means standing in the rain, than turn up on time only to find you have missed the bus and have to wait an hour for the next one.
It’s too early, for there may well be another downward leg to the bear market, particularly in US high-tech shares. That next bull market bus could be a year or more away. But I sense that the fear of missing out – the driver of that last frenzied phase of the bull market last year – will soon be replaced by the fear of being left behind.
The third bit of the story is the awareness that UK and, to some extent, European assets are under priced. The UK remains out of fashion for all the well-known reasons, and our escapades of the past few weeks have not helped. European markets are out of fashion because of reliance on Russian gas, and threat of factory shutdowns this winter.
The US remains more fully valued. So while the S&P500 index is down a long way this year, it is still on a price/earnings ratio of 18. The Footsie is down only 2 per cent this year and is on p/e of 13.4, and the DAX, that is 40 big Germany companies, is on a p/e of 12.8. (Mind you, if you really want value, the Hang Seng index in Hong Kong is on a p/e of just over 6, but I can think of a few reasons why international investors might be a bit twitchy about putting money there.)
This value story will I think have legs over the next two or three years. The giant companies listed in London and Frankfurt (or indeed Paris) are really dependent on the global economy and can therefore look beyond the problems currently facing the UK and Europe.
None of this will make the coming months any easier for British taxpayers and homebuyers. The best things that can be said about that is that we are heading to whatever next year holds with competent governance; that with rates at 3 per cent they could be three-quarters of the way to a peak around 4 per cent; and that the investment community may be starting to look beyond the recession valley to the uplands on the other side.