Julian Chillingworth, chief investment officer at Rathbone Unit Trust Management Limited, says the months ahead will be a mixed tale for earnings and outlooks.
Equity markets have climbed +30% since their March lows. Technically speaking, there is little dispute that we have experienced a bull rally. The question now hangs on its sustainability, and what we can expect from the coming months. Have the bulls more to cling to than just sentiment and liquidity?
Bank-led recessions are different from (dare I say it) their more mundane counterparts. They are more complex, take longer to resolve and are capable of throwing historical precedents out of the window. But it is historical precendent to which we turn when attempting to decipher where the market might move next.
At the time of writing, indices are hitting new highs; economic data, whilst encouraging are far from uniform, and investors remain overly-influenced by the Chinese market, which is currently very volatile, and driven by debt concerns. But in the broadest sense, investors have concluded the worst was over at the end of June/beginning of July, and are pushing markets upwards.
What will be interesting is the direction markets take in September and October, which have, in the past, proved interesting months. This should help us better understand the over-arching mindset, and whether the current rally has the power to break the 5000 barrier.
September is usually a mixed month for markets. City big boys are back from their holidays, and positions and allocations are reviewed. This is a month for consolidation, where much is predicated on the macro picture as company news (figures, profits warnings) have usually been declared to the market in the preceding two months. October, on the other hand, normally presents a more acromonious time when investors become anxious about Q3 earnings and the outlook for 2010.
This is when markets are vulnerable to profit-taking and volatility. September and October are also very much influenced by companies assessing budgets for the coming year. So any movements during this time are significant. Should markets continue as history suggests, we can assume a level of rationality. However, should they continue onwards and upwards, regardless, perhaps it's time to be wary.
Here at Rathbones, we expect markets to trend upwards towards year-end, but not without some volaility. On balance, the rate of economic decline is slowing, although regional variations remain. The US and Europe are in much better shape than the UK, as is Asia, for that matter. Debt levels remain especially high in the UK, which must also contend with financial services as its core offering.
Capital markets have started to thaw, and extreme policy measures have certainly rescued us from brink. But questions, big questions, remain over the sustainability of earnings; the employment trend; the potential for further problems with banks and lending; the Chinese debt problem; demographics, savings rates and deleveraging, and finally, the implications of stimuli thrown at the system. As one commentator smartly concluded, "we're in the middle of an unprecedented crisis, brought on by never-seen-before financial behaviour [sic], against which novel remedies are being attempted. And yet many people seem to think that a business-as-usual recovery lies ahead." It is against this backdrop that we remain cautiously optimistic, at least until a clearer trend can be deciphered.
We will certainly be monitoring movements in September and October, and asking whether this rally is both short and shallow, or whether there is more to this game then hope. However, we are in no doubt that there is value to be had in this market, opportunities that make for long conviction buys. In particular, there are many good small and mid-cap companies -to whom banks remain effectively shut - and are looking to refinance. The economic recovery may only be starting, but it remains challenging and fragile, and the market ego remains fragile still. Tread carefully, but certainly no need to rush for the exit.
Julian Chillingworth is chief investment officer at Rathbone Unit Trust Management Limited
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