FT MONEY: Beware seismic shifts in sentiment Suddenly, equity investing is so 1990s. So the speculative caravan has moved on to the likes of gold THE LONG VIEW - PHILIP COGGAN
Financial Times; May 4, 2002
By PHILIP COGGAN
Equity markets in the US and Europe have been busily going nowhere so far this year, but this apparent immobility is rather misleading. There are some tectonic shifts taking place elsewhere.
The most noticeable change is the enthusiasm for real assets. Suddenly, equity investing is so1990s; it is not much fun being a momentum player if your chosen asset is stationary or going backwards. The speculative caravan has accordingly moved on to the likes of gold and gold mining shares; gold is at a two-year high and the FTSE gold mines index is up 52 per cent since the start of the year.
In the UK, residential property enjoyed one of its best ever months in March. To the average UK small investor, buying-to-let looks like a much better option than a pension, with its high charges and complex regulations, or an investment in an equity market that has gone nowhere for four years.
Clearly, the liquidity that was pumped into global economies during 2001 is finding an outlet. This creates a similar dilemma to that faced by central banks in the 1990s - if inflation on the high street is quiescent, should they worry about rising asset prices? This time round, the institution in the firing line is the Bank of England rather than the Federal Reserve.
The second big shift in financial fundamentals is a change in attitude towards the dollar. So far, the dollar's decline has been relatively small-scale, with the euro edging back above 90 cents, its highest level of the year.
But the change in sentiment may be more important than the scale of the movement. It has come in spite of a robust US growth rate of 5.8 per cent (annualised) in the first quarter, although that was boosted by a slowdown in the rate at which companies were running down their inventories.
Investors are now focusing on the problems they ignored during the late 1990s, notably the US's large current account deficit. This did not narrow significantly during last year's economic slowdown and could thus widen alarmingly during the recovery.
The US's ability to finance that deficit has depended on the willingness of overseas investors to buy US assets. This proved no problem in the late 1990s when the US had a much more vibrant economy and stock market than either Europe or Japan. But if overseas investors suddenly lose their enthusiasm, a whole new set of problems will emerge.
A strong dollar has suited most of the world in recent years. Europe and Japan have, in effect, been able to export their deflationary pressures to the US; and the US economy has been strong enough to take the strain.
If the US dollar were to decline sharply, that would put severe pressure on European and Asian exporters and thereby on global growth. As Ashraf Laidi of the MG Financial Group points out, the US buys nearly a fifth of the world's exports.
It would also cause a dilemma for the US Federal Reserve. A falling dollar would add to inflationary pressures on the US economy. But increasing interest rates to choke off inflation would not necessarily support the dollar; these days, currency movements seem to be driven more by economic growth expectations than by yield support. And higher US interest rates would only increase the strain on the rest of the world economy.
Is it possible to link these two big movements - the enthusiasm for real assets and the change in sentiment towards the US dollar?
Arguably, investors are still adjusting to the disinflationary forces that worked their way through the global economy in the 1990s. For much of that decade, these forces were seen as entirely positive, pushing down bond yields and pushing up share valuations, and creating substantial capital gains.
Now, however, the markets are not quite sure where they can go from here. There are essentially three possibilities: a slide into deflation; a continuation of low inflation; and the return of inflation.
Deflation seems to have been avoided, for the moment, by last year's decisive action from central banks. Indeed in Japan, which may have reached the meltdown point for government finances, some economists are now warning of the danger of inflation in the medium-term.
A continuation of low inflation would certainly be the ideal option from the market's point of view, but it is probably priced into equities. It is thus hard for investors to get excited about this option, especially as the prospects for corporate profits are still in doubt.
So instead investors are in the mood for questioning old certainties - and that means accepting the possibility that inflation might return and that the dollar might cease to be the world's strongest currency.
September 11 and the collapse of Enron may have played a part in this mood change. Suddenly, the assumptions that the US is a political safe haven and the market with the highest accounting standards are open to question. The US, indeed, is the source of one of the biggest uncertainties in the minds of investors at the moment; whether the Bush administration will launch an attack on Iraq later in the year.
These trends are not yet irreversible, although the nature of modern markets is that investors are eager to jump on the latest bandwagon to pass them, whether it is buying emerging markets in the early 1990s or technology shares in the second half of that decade.
Bulls of the dollar may still be saved by the lack of an attractive alternative currency - given the diminishing hopes for economic reform in Europe or the worsening fiscal problems of Japan.
philip.coggan@ft.com
Copyright: The Financial Times Limited 1995-2002
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