Interpreting the various signals sent by financial markets remains a puzzle, a quite tricky one in fact. Some equity markets have rebounded by 40%+ since the trough in spring 2009 and it seems difficult to justify this strong upward move by just looking at commonly used value measures.
The Dow Jones rose a stunning 4000 points since spring alone and Asian markets basically doubled in the last 9 months – it’s hard to explain such large movements looking at the economic challenges we still face. It seems that normal markets have already priced in a very impressive recovery. Subsequent to the market’s rapid rise, many investors, having missed the run up, are reluctant to put money back into markets after such a huge rally.
The fact that gold has moved to new record levels at the same time seems confusing, since it is considered to have defensive character in investor portfolios. And then there is the question of interest rates. The rates are still at very low levels and central banks are keeping a lot of liquidity in markets in the hope that this will eventually bring credit markets back to life. These are conflicting signals and it’s hard to explain all of those movements within the same context. We feel that each of these movements does indeed make sense.
Our interpretation is that the recent recovery of equity prices needs to be seen as an exceptional movement, a recovery from a “once in a century” type of event, which caused a huge overreaction of general markets.
Where does the Dow stand today? The answer is around 10,500. Where did it stand in 2004? The answer is around 10,500. Then again, where was the index in the year 2000? The answer – you guessed it: around 10,500. It’s been a lost decade for purely domestic equity investors in the U.S, but not for other markets. Where is the Hang Seng index trading today?
Answer: around 22’000 points. Where was it 5 years ago? Answer: around 11’000 points. And where was this index about 10 years ago? Answer: Below 10’000 points. Equity markets still offer a lot of value, but, often this value must be sought out in new markets – the ‘field’ of play has become global. The following chart shows the relative performance of the Dow compared with the Hang Seng, Hong Kong’s main index.
When one looks at interest rates around the world, things start to make sense in a larger context. Central banks will keep ample liquidity in markets for the time being and will not start hiking rates immediately – global growth is still too fragile. Of course, short-term rates have to eventually rise in 2010 and we think this will happen in the second half of the year.
Again, however, the situation needs to be seen in the context of dealing with a “once in a century” crisis. Gold has recently moved to record levels and it has been one of the best performing investments in the recent past. Should investors be worried about the upward trend of gold and take it as a sign that there is trouble ahead? In our view the answer is no, we wrote about the changing importance of gold in our previous reports and do not think that gold is all that expensive at current levels.
Again, once current prices are seen in a historical context, considering inflation and the weakening U.S. dollar, gold is not expensive at all. Also the obvious willingness of emerging markets and their central banks to use gold as an additional way of diversifying their reserves will be highly supportive for the yellow metal in the years to come.
Disclosure: No positions