Then And Now

02/08/2013 at 3:55 pm

The S&P 500 index has roared through 1700 for the first time ever. US GDP for Q2, expected to come in at 1.0% annualised, hit 1.7% on the advance estimate instead. Jobless claims reached a new five-year low. It is clear in some quarters that “the US is the engine of global recovery“.

Elsewhere, enthusiasm about the growth data in particular has been tempered. After all, the number for Q1 this year – which began life estimated at 2.5% and was later cut to 1.8% – was revised down further to 1.1%. And the figure for Q4 2012 was cut to an almost flat 0.1%. In fact, in real terms the American economy expanded by a rather torpid 1.4% over the full year from Q2 2012 to Q2 2013.

Which brings us on to the stock market. The S&P 500 is 25% higher than it was a year ago but reported earnings per share for the quarter so far (393 index members) are up by only 3.6%, and have actually fallen by 2% for non-financials. So over the last twelve months the p/e ratio has jumped back to its pre-recession level – about in line with the long run average for the index. US stocks are not yet expensive by this measure but they are no longer cheap.

This is not to knock the rally. There is a bigger gap between rhetoric and reality than there is between reality and market behaviour. Confidence and activity indicators are consistent with continued, solid growth, albeit at a sub-trend pace, and that’s always better than the alternative. There was a marked correction across equity markets in May-June, which slowed the pace a little, and there will doubtless be more volatility to come. It does not look as if there should be much reason to argue with a measured, patchy uptrend in the US stock market. That’s what’s happening to growth and earnings too.

It is instructive to compare the lie of the land this year with the immediate aftermath of the credit crunch. In 2009 confidence began to improve way before the Great Recession ended. It became clear that capital losses and writedowns in the banking system had peaked in Q4 2008, and that was enough for the S&P to return 50% over the year to 31 March 2010. It was not until the Greek crisis that the scale of contagion began to be more widely understood, and market confidence has still not fully recovered from the demeaning misery of having to absorb fixed income ephemera such as what a “Fitch” is and how one might go about swapping a credit default.

So US equity has shown about half the exuberance in price terms since last summer as it did over the 12 months from Q1 2009. Again, let us stress that this does not appear unreasonable. But back in ’09 of course it was not just a select group of developed-world stock markets that embraced the transformation in morale.

Over the same 12-month period – from Q1 ’09 to Q1 ’10 – the MSCI Emerging Markets index returned 82%. The yield on the ten year Treasury rose by 1.4%. The trade-weighted dollar fell by over 8%. Investment grade credit spreads in Europe fell by 95bp. Brent crude futures were up 68%, COMEX copper futures up 93%.

Much of this seemed absurd at the time, and in hindsight seems especially so. What is useful, perhaps, is to note what a really abandoned recovery in confidence looks like, and to compare these numbers and others with the very much more tentative present upturn.

The move in Treasuries has been similar, with the ten year yield up 1.2%. Compared to ’09, therefore, bond bearishness has outpaced stock market optimism. And that optimism has been much narrower: the MSCI EM equity index has returned only 4%. Credit markets have broadly kept in step with Treasuries, tightening by most but not all of what they managed back in 2009-10 (80bp so far). On the other hand oil has gone nowhere and base metals have fallen.

There are always risks and always fundamental changes to consider. So there were four years ago. What differentiates markets today is that they are less certain – more confused – than they were back then. If the confidence felt on Wall Street is justified, and if this confusion should diminish, there are a number of dots which need to be joined before the picture across asset classes looks composed once again.


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