Walking the tightrope or plank?

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Rowan Dartington Signature’s Guy Stephens assesses how worried we really need to be about the dark clouds looming over markets

The list of big market stories that could cause volatility is getting longer and it is quite difficult as a practitioner deciding how worried one should be. The current order of magnitude is probably as follows; War in the Ukraine, Greece exiting Europe, European deflation, the UK election and the Chinese slowing economy.

The equity market remains near all-time highs when previously the first three of these issues have caused market sell-offs. We know that unexpected uncertainty is one of the biggest causes of volatility in markets, and the one thing these issues have, is they have been known about for some time.

They are also geopolitical in some cases or isolated economically and so the rational investor who looks at businesses from a bottom up perspective will conclude that they are either earnings neutral or priced in. But only if his glass is half full.

For now, despite pressure on Obama to act, there is no appetite for a war in Europe and the US inaction in the Middle East with IS supports this. Some sort of peace deal is looking likely as Merkel meets Obama in the US and Putin’s latest statement on the expansion of NATO puts the dispute in sharp contrast.

Greek bonds are pricing in default and the markets continue to believe Mario Draghi’s support pledge which is stopping contagion. So if Grexit happens, so be it. The deflation issue is economically supportive at the moment and if the Chinese decide to break their currency peg to the dollar to support their ailing economy that will bring another wave of downward pricing pressure in the West.

That will also be a significant boost to the consumer and for commodities but not so positive for Western manufacturing exports, but then how much of that which moved east has really moved back ?

There remains only one attractive mainstream liquid asset class, namely equities. Holding cash at the moment is expensive in relative terms and is only temporary ahead of hoping to re-enter the market at lower levels following a correction. October and December saw falls on the FTSE-100 of almost 10% to below 6,200 which were then retraced very quickly. Investors are reluctant to sell because it is clear there are plenty of buyers out there who need an income or capital return.

The argument for holding cash relies on no return being preferable, and that requires a very bearish outlook when the US has just returned the strongest employment data since 1997, the UK is growing robustly and QE in Europe is just about to start.

There are many dark clouds floating around at the moment, but these could clear considerably over the next few weeks as the world becomes ever smaller and every political move ever more transparent. At least everybody is talking and brinkmanship is giving way to some degree of sensible dialogue.

We elect our leaders in the West to keep us safe and secure and not to pursue egotistical displays of national power. Perhaps this lesson has been learnt from Iraq and Afghanistan and we are now entering a new era of transparent global co-operative diplomacy. We will find out very shortly.

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