Delphi’s Espen Furnes says expectations of the death of the stock market are premature
Inflation could be the ‘joker’ that changes everything in a world where currently most people want to invest in debt instruments says Espen Furnes, manager of Norway based Delphi Europe.
The trading volume in stock markets this year has been well below half that of the levels before the financial crisis. We hear about players gradually withdrawing from shares almost every day. This is in sharp contrast to conditions in the debt markets. The credit market in particular is experiencing its biggest boom ever this year. At the same time, the interest paid on both short-term and long-term government bonds is very low. Nonetheless, some people believe that shares are for losers.
It can be useful to remind people what a share really is. A share is an ownership stake in a company. A company has different assets and its main objective is to create value for its owners, i.e. shareholders. Many companies succeed in this. In fact, the total value creation of the companies listed on the world’s stock exchanges has been positive in almost every one of the past 30 years. None of this indicates that shares are a dying investment class – on the contrary. In order for the value of the stock market to drop to zero, all the companies would have to make huge losses for years. That will not happen. What is most likely is that the companies will continue to create more and more value, just as before.
Of course, the debt market has an important function, especially nowadays when banks are more interested in building buffer capital than in ensuring good, long-term financing for their corporate customers. In such a situation, access to the credit market is important to most listed companies. Access to the debt market is important to countries too, since this is where they obtain a considerable percentage of the money used to keep them running.
Inflation is the big joker in the debt market. The market for interest-bearing securities with a long term to maturity, and especially the market for government bonds, is very sensitive to inflation. The interest rates in the government-bond market are extremely low, in fact far below the levels for normalised inflation. The ghost of inflation has been absent for many years. Instead, recession and deflation (falling prices) are what people have feared since the financial crisis started. The financial crisis has also led to most countries starting to print huge amounts of money to safeguard their national finances and fund expensive rescue packages.
At the other end, the buyers of national debt have been standing ready and welcomed this with open arms – and have also been willing to buy at increasingly low interest rates. So far, the money printing has not caused higher inflation rates. However, we expect the money printing to continue and that several economies, especially the US, will show signs of recovery. In such a scenario, inflation rates will increase at some time or another. This does not harmonise well with the current pricing of long-term interest-bearing securities, which is based on the implicit assumption that there will be low inflation rates for many years to come. In our eyes, this is unrealistic. When inflation starts to rise again, there will be many investors selling bonds.
Here at Delphi, we like shares. We believe that listed companies will create a lot of value in the years to come, to a large extent driven by improvements in the US economy which will provide a basis for better times elsewhere in the world. In addition, we select shares for our portfolios that can be expected to create more value than the rest of the market. However, in order to be paid in full for our standpoint, we are dependent on the stock market being able to include this growth in the share prices. In order for that to happen, there must be more interest in shares.
Inflation affects the stock market and debt market in different ways. Companies raise their prices in line with inflation, so that their earnings are in practice inflation-proof over time. This is in sharp contrast to the debt market, where just a little inflation will have clearly negative effects. For this reason, we know that shares will regain their popularity when inflation starts to rise. The question is not whether this will happen, but when…