Whilst it’s hard not to be distracted by the ever changing political story – sterling was driven to a two week low against the euro and weakened three cents against the dollar because of the pressures on the UK government – investors are also having to keep their eye on the growth ball and wonder whether stocks are getting ahead of the real economy. CNBC commentator Doug Kass has described the March low as a ‘Susan Boyle’ moment – one that took market participants by surprise – but in the long rally since equities have fully discounted ‘the second derivative recovery’. We are getting to a point where the trajectory of economic growth will be shallow and likely to disappoint stock markets during the second half of the year.
Cyclical shares like miners have come a long way and to progress further will need more revisions to earnings forecasts. But those revisions will have to be driven from a pickup in top line growth rather than cost cutting and that’s where the problems start. With unemployment continuing to rise, the consumer will remain very weak. It’s probable that savings rates will remain high and personal consumption expenditures remain low for an extended period of time. Add in the spectre of rising taxes and higher interest rates in terms of higher bond yields and what’s a fragile recovery in the economy and in the markets could easily stall. In short, the weakened state of the consumer is perhaps the most significant medium term challenge for both the market and economy. In the near term there are still likely to be investors who want to take more risk and by pointing to continued growth in Asia suggest that commodity plays are the way to get exposure. Countering that is the view that a lot of stocks in this space are now fairly valued against defensives like pharmaceuticals and utilities and institutions normally like some disparity to be fully engaged. Of all the sectors perhaps banks are still the most intriguing. I’ve written before about the potential long term drag on earnings from continued write-down but for those with manageable exposure there’s an old saying, ‘Steep bond yield curves mean big bank profits.’
Ross Westgate anchors Strictly Money each weekday on CNBC.