The Equity Picture Improves in the Developed Markets

by Inya Ivkovic, MA

During the second quarter of 2009, investors in the developed
markets enjoyed much-needed and even more welcomed relief, as “risky assets,” as they’re called in macroeconomic lingo, rallied, while all the so-called “safe havens,” the primary investment choices of 2008, became noticeable laggards. Regardless, the spring surge has been met with plenty of doubt and caution remained the key investment strategy. After all, the global economic growth remains weak, businesses are still operating well below their capacities, and enormous debt burden is not decreasing. Rather, the case is quite the opposite.

Despite my overall pessimistic nature, or my cautious nature, I feel inclined to believe that the equity markets have it right. By all means, the third-quarter stock market gains are likely to moderate, but falling off the edge again into the deflationary abyss doesn’t seem likely either. True, growth prospects in the near term appear dismal, but at least there is improvement in sight. Capital markets have offered some flexibility to cash-starved companies and liquidity conditions worldwide are continuing to ease globally.

Market observers are seeing the strongest evidence of recovery in the government bond markets. Longer-term yields have increased sharply in the second quarter, particularly in Australia and the U.S. And, while the yields offered promised no shortage of buyers, the actual drivers behind them were lessened deflationary risks and light at the end of the GDP growth tunnel.

As for capital flow, financing activities during the second quarter were by no means limited to the public sector. The private sector staged an impressive comeback, all things considered. New equity offerings during the recent quarter exceeded $200 billion worldwide. Of course, the public sector was substantially more prolific, issuing almost $1.5 trillion of the investment-grade securities and about $50.0 billion in high-yield paper. This much activity must have padded quite a few balance sheets, not to mention that it helped restore investor confidence in both fixed income and equity markets.

As long as money is flowing through the financial and credit systems, derailment of equity prices in 2009 would require a deflationary explosion of significant proportions. Potential sources of trouble ahead could be levels of indebtedness among the developed economies, sharply declining earnings levels, certain industrial sectors having difficulty to make ends meet, etc. On the other hand, the ultra-low-interest-rate environment might soften any such blow, if not defer it completely. Economists agree that, on the path to recovery, the biggest danger remains capital starvation and cutthroat competition that may arise as a result.

It has been an emotional ride in the past year, which is why equities still feel far too volatile to many investors and any green shoots of recovery could be taken as a platform for selloffs and locking in at least some gains. The concern is that, with money being easier to obtain and with healthier fundamentals developing, more selloffs are imminent. At this point, I believe most of the volatility has already been factored in. And, as more investors are growing impatient with low money-market returns, equities appear to be more and more attractive.