Dangers ahead despite bull market

Allister Heath
YESTERDAY was the first anniversary of the bull market. The FTSE 100 has soared 57 per cent since reaching 3,460 on 9 March 2009, a six-year low, closing at 5,602 yesterday. The S&P 500 touched bottom at 676.53 this time last year; it has since jumped 70 per cent. This has been a dangerously exuberant and speedy rally. On Robert Shiller’s measure of the price to earnings ratio, US equities one year ago were undervalued by a fifth; they are now overvalued by a quarter.

In fact, as Jeremy Batstone-Carr of Charles Stanley reminds me, one year on and every main asset class apart from US Treasuries has made gains. Emerging markets and small caps have led the charge. High yield bonds have surged, though gold has lagged and the greenback is down. Gluskin Sheff, the Canadian firm, has listed some of the changes over the past year. We truly live in a different world.

Oil this time last year was trading at $47 per barrel; it is now at $82. The US economy was shrinking at an annualised rate of 6.4 per cent; it is now growing at 5.9 per cent (the contrast is not quite as stark in Britain). The ISM gauge of US sentiment was at a depression-level 36; it has now bounced back to 57. In the UK, services sentiment has rocketed.

The Chicago Vix volatility index was at 50 (indicating elevated risk); now it’s at a ridiculously low 17. The yield on 10 year US Treasuries was 2.9 per cent; it is now 3.7 per cent (fixed income investors have been hit). The US budget deficit was $900bn, now $1.5 trillion; Britain’s deficit has also exploded. Spreads on Baa-rated assets were 540 basis points and tightening, suggesting huge (but shrinking) risk aversion; they are now 260 basis points (suggesting a more relaxed approach by investors) and widening.

One year of buoyant asset growth tends to be enough to anesthetize markets. Many extraordinarily difficult decisions need to be taken in many countries – not least how to bring down out-of-control budget deficits, how to normalise central bank interest rates and how to boost savings to plug the banks long-term funding gaps. A geopolitical catastrophe remains a real possibility, while a sovereign debt crisis, a renewed house price crash and the return of inflation are all serious risks.

Yet few of these terrifying pitfalls have been properly priced in by the markets. There can be no doubt that the world economy is in much better shape than it was a year ago.?Any return to complacency would be catastrophic, however.

NONSENSE on stilts

Here is a great and original idea from our friends in Brussels: when in a debt crisis, shoot the messenger. Instead of blaming Greek and other politicians for over-spending, the Eurocrats would rather slam the “irresponsible lenders” and “speculators” who have priced in a greater risk of default into the credit default swaps market.

The truth is that governments have behaved recklessly and are now paying the price. Markets, if anything, have been too cautious; bond yields should be even steeper.?There is no evidence that the CDS?market has caused – rather than highlighted – the crisis. We should never forget how at the height of the credit crunch, HBOS’s shares started to collapse. The ?authorities were furious: there was nothing wrong, they insisted, merely scurrilous hedge funds manipulating stock prices. Needless to say, the speculators were soon vindicated – and the regulators went very quiet. Plus ca change… allister.heath@cityam.com