Equity markets have started the year on a positive roll, with most major markets rising in January somewhere between 4% and 9%. The German, US and UK markets are now approaching something like a 20% return from the October lows. It is likely the January rally has been predicated on short covering and positive seasonality – the January effect, combined with more aggressive lending by the ECB. These rallies still form part of a trading range dictated by risk on, risk off trading and are to be rented for the short term and not owned for the longer term.
Global debt issues and poor economic performance are likely to continue for some time yet. Japan is in contraction, cutting its GDP forecasts from +0.3% to -0.4% for the fiscal year. Spain’s Q4 GDP was negative and the Spanish government has downgraded its 2012 forecast for economic growth to -1.5%. Virtually all of Europe is already in recession. Whether China can engineer a soft landing remains to be seen, but a soft landing from a housing bubble is as rare as a Unicorn. In the US the recent data, after stripping out seasonal smoothing due to unseasonal warm weather, is actually not that encouraging and growth is likely to be sub 2% for 2012.
There are growing signs of deflation across the world. NZ, Germany and Canada have printed negative numbers. Chinese house prices are declining across nearly all regions and the US is close to deflation on a three month view. Whilst equity markets have re-rated off the back of central bank stimulus, inflation has not followed.
In the US, the current earnings season is flashing warning signals. Sales growth is slowing, earnings are sequentially contracting, margins are now declining from record highs and the number of companies that are beating estimates is now running below average compared to the last four quarters.
Investors seem to be acting as they did in the early months of 2011, putting blind faith in central bankers and politicians.
The investment focus for disciplined investors should continue to be on stable cash flows, earnings stability, dividend growth, strong industry dynamics and quality of management. These companies should continue to outperform through volatile markets. Hope is not an effective investment strategy.
Mark Warminger