Caution is key for many investors at the moment – but is it really cash under the mattress time? The experts who are telling investors not to panic and to continue to take risks may yet be proven right, but there is an increasing number of unprecedented unknowns and potential pitfalls in global markets today.
Disappointing growth, particularly in China, the end of the quantitative easing era, weak company earnings, and concerns about when the US Federal Reserve will start raising interest rates all rank among the most important factors causing confusion.
“Never have we seen so many clients who just do not know what is happening and have cashed up,” equity analysts at Credit Suisse recently flagged.
Concerns about China seem particularly apposite as the country’s President Xi Jinping arrives to enthusiastic welcome in the UK this week.
The world’s second largest economy’s growth may be slowing slightly less than feared. But it is still facing its first ever prolonged slowdown in growth since it became one of the most integral parts of the global economy, and trust in its policy-makers to deliver is sinking among investors, particularly in the US.
The cliché goes that, when the United States sneezes, the world catches a cold. But what if the equivalent with China is pneumonia?
There is plenty of food for bearish investors when it comes to the US, too. High yield credit spreads have been widening, which historically has sometimes been a sign that a recession may be on its way. The vast majority of borrowing by US businesses is financed by the credit market, which is why the spreads are often assigned huge importance.
In the eyes of the stock markets, the Fed, led by chair Janet Yellen, appears to be damned if it does and damned if it doesn’t raise rates. If it goes ahead in December, as many are now forecasting, it risks looking like a poor communicator to the market and over-optimistic on the US recovery. If it doesn’t move, the world’s most important central bank may be left without much room to manoeuvre when the next downturn comes.
When the Fed is as cautious as it appears to be at the moment, it’s no wonder investors are too.
Still, there are rewards for taking risks on the markets. If you look at the key measure of risk rewards, the Equity Risk Premium – the extra return that stock market investing provides over a risk-free rate like US Treasuries – it is around 8 per cent in Europe at the moment, well above the post-credit crisis average of 7 per cent. That is reliant on picking the right risks, however, and with visibility as poor as it is at the moment, that seems a bit like driving with a fogged-up windscreen.
City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.