Trading floor of the New York Stock Exchange
Are shares, or to give them their correct name, Equities, divorced from reality or are their current high prices actually telling us something?
In recent months Stock Markets have been surging, but the question that you really should be asking is; for just how long can they continue to defy gravity?
Recently we’ve had a string of bad news stories, the UK growth forecast cut to 0.6%, US unemployment up and growth stalling, not to mention the recent crisis in the Eurozone over Cyprus; but the effect on Stock Markets has been minimal.
Now it is true that stock prices are forward looking indicators, so what has happened in the recent past may seem only mildly relevant. Even so the apparent divorce between share prices and the current economic reality has never looked as wide as it is at the moment, with flattening growth and soaring equity prices
Why is this happening?
Well, the current bull market (i.e. share prices rising) is driven primarily by the absence of severe negatives rather than by any genuine belief that the light at the end of the tunnel has suddenly got a lot brighter. Most economists believe that the Eurozone will muddle through somehow, the US has avoided going over the fiscal cliff and China’s economic readjustment seems to be working.
There are also very few alternatives; buying government bonds from a safe country, brings minimal returns as does leaving the money in interest bearing deposit accounts. So with no really bad news and low returns elsewhere, investors have piled into the Stock Markets, causing the current rising prices.
Also, when times are hard the number of transactions taking places in an economy declines and with it the demand for cash to fuel those transactions. Money instead gets parked in bonds or deposit accounts, driving interest rates lower and adding to the trend of deflation; which is precisely what has happened over the last five years.
So without hedge funds, high worth individuals and big companies investing in the economy Central Banks have printed money and pumped it in (Quantitative Easing), from the ECB, the Bank of England to the US Federal Reserve Bank. This is the underlying cause of why interest rates have plummeted and has driven investors back into higher risk assets, namely equities.
Can it last?
The quick answer is no! and some time in the next 3 to 6 months there will be a correction. Equities are beginning to look a little pricey again with the PE ratio falling (Price Earnings Ratio: divide the latest share price by earnings per share or EPS. So, if the current share price is £10 and EPS is £1, the p/e ratio is ten).
Senior Partner David Jones ACEA C’Dip AF
So, if you own some shares you should consider bed and breakfasting (selling your shares at or close to their peak and repurchasing them after the market has fallen). However this can be dangerous territory if you are not an expert.
In my opinion the market will be higher in a couple of years but there will be a fair amount of prices zig-zagging up and down before we reach the promised land of sustained growth.
Morgan Jones & Co have 27 years experience of acting for SME’s; so if you need an Accountant, follow the Competition Commission’s advice and contact a firm with a proven track record in this sector
David Jones is the Senior Partner and Founder of Morgan Jones & Company. Born in Liverpool and an Accountancy graduate of the University of Wolverhampton, David spent twenty years working for the Customs & Excise in London then Shrewsbury before starting his own business. David's depth of knowledge of the UK tax system and his ability to communicate this learning has seen Morgan Jones & Company grow into Shropshire's most respected Accountancy Practice.