Of course, the dangers posed by JPMorgan’s imminent departure will remain theoretical until trade in the repos (essentially short-term, collateralised loans) is stymied – and that may never happen. But there is a rather more obvious threat to liquidity as central banks start turning the screw, not just in terms of interest rates, but through the withdrawal of monetary stimulus. You would have been justified in voicing that same fear at the outset of 2017, as there was no guarantee, indeed little expectation, that equity valuations would progress as they did through the year.
In the event, the FTSE 100, a relative laggard through 2017 because of its peculiar weightings, still increased in value by 7.1 per cent, while continental markets surged ahead, evidenced by a 16.8 per cent rise in the FTSE Developed Europe ex UK Equity Index. You could argue that the continued buoyancy of these markets would not have been possible without the support to asset prices provided by external stimulus, but European Central Bank intervention could trail off significantly in 2018. Closer to home, the Bank of England may opt for action over rhetoric in relation to interest rate hikes, although, given the squeeze on discretionary incomes, this seems a remote prospect.
Across the pond the Trump effect is in full swing. The US economy grew at its fastest pace in more than two years in the third quarter, and the country’s debt issuance is at new highs, suggesting that buybacks, dividends, debt reassignment, M&A and capital expenditure plans are still to the fore, but there’s a little more caution priced into UK equities despite the nominal highs – never a bad thing. The reason I’m banging on about this (again) is that if you strip out the effects of share buybacks and various accounting wheezes, equity markets in the UK, the US and Europe remain overvalued from an historic perspective (the UK offers the most compelling valuation from a forward price/earnings basis). This is hardly news, but it would be pure folly if our circumspection (certainly in the case of the UK) gives way to complacency.
A wider kind of torpor may already be reflected in the Vix ‘fear’ Index, a measure of expectations of future market volatility, which was down by a fifth in 2017, hitting a record low, but a possible pointer to a prevailing view among institutional investors that central banks are still unwilling to take a hawkish stance on monetary policy.
The odd thing is that even though just about anyone you speak to will readily admit there is a disconnect between underlying earnings and share price growth, you might still be assured that this time it’s different, that the historic ratings no longer apply. It’s a disingenuous view, as if mean regression is an arcane dynamic, but even more curious when you consider the rotation from value to growth stocks. In truth, anyone with a passing interest in the market will be trying to identify the most likely catalyst for a substantial pull-back in the major indices. With corporate balance sheets in decent trim and the Trump administration’s stimulus initiatives yet to kick in, the draw of risk assets could persist for a while yet.
But leaving aside issues linked to liquidity, and assuming there’s no major correction in the early part of the year, there’s an additional risk factor that UK investors will need to keep in mind. Although it’s unlikely that the Bank England will risk inverting the yield curve through a succession of interest rate increases through 2018, it’s conceivable that we could witness a marked write-down in equity valuations if the Republican Party was to lose control of either House come November in the US mid-term elections.
