Looking at the markets long and short term

7 December 2010

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As we near the end of what has been a volatile year for markets, we can consider the outlook for both the long and short term. Long term, all macro economic data indicates a sustained, albeit unspectacular economic recovery, with the general picture improving worldwide. However, as investors we remain vigilant about the short to medium term outlook – sentiment is still fragile, and markets are highly sensitive to economic data and news, which has been mixed over the last few months.

On the positive side, during the recent company results season, 75% of companies surprised on the upside, and results were underpinned by revenue growth of around 7-8%, rather than cost-cutting. Other announcements, including outcomes of US mid-term elections and a second round of quantitative easing, were also considered positives by the market. More recently, the fact that China's economy is continuing to surge forward, and that US economic news has been mixed to good, is also aiding market progress. Markets are now on more of an upward trend; back to being close to the previous 2010 highs. In December, they could move higher, with the possibility of a seasonal ‘Santa rally' across global markets.

However, markets have also had much to be unnerved by recently, with the Irish debt crisis and subsequent bailout leading to market volatility. Europe's sovereign debt issues continue to be a major concern with the spotlight now on Spain. Actions by policy makers attempting to maintain stability can lead to market falls or rallies – most recently markets rose on the news that the European Central Bank is encouraging banks to buy Spanish debt. More generally, the overall fear and negative sentiment that remains post-crisis makes for continued swings in sentiment and volatility. Furthermore, the market's credit transmission mechanisms are still impaired. Central banks are pouring money into economies (QE) but it's not getting to consumers and SMEs. Consumers don't want to take on more debt, while smaller companies often cannot secure loans because they're perceived as high risk. This means there's a lot of surplus liquidity in the market.

Predicting the evolving environment is a challenge. We think the surplus liquidity could create asset bubbles, if the credit markets remain impaired and the money simply drives up asset prices. Going forward, equities in particular will have to be monitored closely for any signs of unjustifiable valuations. Another outcome is that the liquidity may travel first into the emerging markets (via the US using QE Dollars to buy back US treasuries from China), stimulating further global growth which then spills back into the US and finally delivers the desired growth impact there.

In the shorter-term, there is good potential for stock market gains, but we will also see volatility in global stock markets, particularly within emerging markets where investors' response may be a risk on/risk off approach. Working on behalf of investors, we remain focused on navigating the markets over the shorter term, as we look to recovery over the long term.

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