Swans, hawks & doves – Rowan Dartington’s Stephens view on the US

Rowan Dartington Signature’s Guy Stephens describes how hawkish policy at home, dovish messages from the US and possible Black Swans in international markets will impact UK investors.

So far this year we have had a heady mix of ornithological references which market commentators like to use.

Swans (or rather Black Swans) refer to a market event that comes out of the blue and is very unexpected. It is difficult to assess at the time whether it is significant or not and can often be incorrectly priced into the market as irrelevant, only to rear its head with a vengeance a few months later.

The most recent example of this was the early warning signs of the credit crunch in the US sub-prime mortgage market. Initially it was felt it was an isolated issue in a small part of the US mortgage market and would cost at most $250bn.

This view persisted for around six months until Lehmans imploded. We have had three similar potential events so far this year in the guise of the Chinese Shadow Banking System, Putin’s invasion of Ukraine and the Sunni uprising in Iraq.

All three have caused some market weakness, only to be discounted as irrelevant and the buyers have come back in and driven the market back up.

The Hawk has been our very own Bank of England Governor, Mark Carney. He upset the markets in his Mansion House speech by specifically targeting the London housing market with references to the need to increase interest rates sooner than the markets were expecting.

This also caused weakness in sensitive areas of the stock market such as house builders, construction stocks and companies sensitive to consumer spending.

The Dove remains Janet Yellen and this is probably the most important of all. Whilst she remains committed to the liquidity withdrawal schedule that is QE tapering without any desire to increase interest rates any time soon, global equity markets will most likely remain relaxed.

Hawkish words from her would be a significant change in stance and this would be very out of character whilst the US remains disappointed with its recovery.

However, all three of these influences for the UK investor are providing a conflict in investors’ minds and this is evidencing itself in our very own asset allocation meetings.

There are reasons to be nervous with regard to US equity market valuations but then again, there is significant momentum behind the stock market and once the earnings for the second quarter hopefully bounce back from the weak first quarter, the elevated valuations may appear justified.

Even if you sell, this is only in the hope of buying back in at lower prices as other asset classes look very second rate. Hence why the buyers have ignored the potential Black Swan events, perhaps at their peril. Time will tell.

Mr Carney’s more hawkish recent comments achieved more in their words than any potential action and in this, he is emulating the US.

It appears unlikely that he will take any risks with the UK economy and so even if we do get a 25bps rate rise in the Autumn, it is likely to be largely symbolic if new mortgage regulations have already been introduced to prevent speculative borrowing for house purchase.

The most likely Black Swan is the Chinese Shadow Banking system which has supported their infrastructure boom and the effect this could have globally.

But the fact it can be seen and assessed somewhat defeats the definition of a Black Swan in the first place and they have continued to extend their building spree into next year.

We therefore come back to the fundamentals of profits and dividends and whether we can see the next recession on the horizon. The answer to this, for now, is an emphatic ‘no’ in which case we continue to back equities albeit with a sharp eye on valuation levels.

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