Broadly, markets have stabilised after a strong start to 2013 and while equities have not regained their early summer peaks, values continue to be supported by improving results announced by many companies in the UK and overseas for the first half of the year. This has generally been accompanied by increasing dividends at a rate that, if anything, has surprised me on the upside. Furthermore, companies have continued to strengthen their balance sheets – all these factors combining to support valuations.
Fixed interest markets are also below their highest levels, this particularly applying to UK and US Government issues as well as debt in a number of developing countries. Uncertainty has arisen particularly in the USA over the timing of the decision to reduce the monthly Quantitative Easing programme, the ending of which is seen as a precursor to an eventual rise in interest rates. One perhaps unexpected result of this speculation has been the degree to which it has unsettled foreign exchange markets in emerging countries where such markets believe that continuing rapid growth is low interest rate dependant. As a result it seems to me quite possible that over the next year or so we will see higher inflation remerge in, for example, India and Brazil. The UK’s position in this, at least in so far as the new Governor of the Bank of England is concerned, is that interest rates need to stay low, probably until 2016, and if markets force them higher it is possible that we will see a return to further Quantitative Easing here in order to underpin Gilt values. In one sense, this is surely encouraging for fixed interest investors and disappointing for those keeping excess cash in the hope of a return to higher deposit rates, but on the other hand there are a number of caveats which could well trigger a rethink at an earlier stage.
Interest rate movements have also impacted equity markets as while a potential move towards eventual higher rates is surely inevitable, it is also the case that higher rates are used by central bankers as a tool to damp down excessive activity and inflationary trends. In my view, eventual interest rate increases need not trouble equity investors to any great extent however as a slow pullback from crisis induced rates will surely be an indicator of better conditions, rather than of runaway excess.
In summary, over the last three or four years I have commented to the effect that interest rates may remain lower for longer, through which period I have been content to overweight equities in portfolios, particularly in developed markets where volatility is generally less pronounced. I consider that this remains an appropriate course for the foreseeable future. I remain concerned about emerging market valuations and continue to hold the view that longer term investors should regard inflation as a threat.