LONDON (Reuters) - Risky assets such as equities and emerging markets may have scope for another rally before the year is out as policymakers renew pledges to keep economic boosters in place given high jobless levels and fragile banks.
Frustrated with near-zero returns on money market funds and Treasury bills, investors are continuing their migration back to a range of higher-yielding securities and that is unlikely to reverse as long as official interest rates stay rock bottom.
Finance chiefs from Group of 20 major economies meet in St Andrews, Scotland for a two-day meeting which started on Friday.
While there have been plenty of signs the global economy is recovering, world stocks suffered a set back in the latter half of October as some investors banked profits on the 75 percent surge of the MSCI .MIWD00000PUS world since March and closed books before the often-volatile yearend period.
The hiatus was confirmed by fund trackers who saw a brief return of inflows to “safe” money market funds.
But concerns eased this week about early or sudden reversals of near-zero interest rates in the major economies. The U.S. Federal Reserve said rates would remain low for an extended period and the Bank of England even increased its so-called quantitative easing, or money-printing, program.
Also, Friday’s data showed the U.S. economy lost a bigger-than-expected 190,000 jobs in October — sending the unemployment rate as high as 10.2 percent — and reinforced the view that official interest rates would not be rising soon.
Next week’s quarterly results from major European banks, including HSBC (HSBA.L), Barclays (BARC.L) and Credit Agricole (CAGR.PA), may also serve a reminder banks remain fragile and are not yet fit to cope with more normal monetary policy.
Global funds monitor EPFR and US trackers ICI and iMoneyNet all confirmed this week a fresh exit of up to $30 billion from U.S. money funds as that low-rate scenario was reinforced.
“We anticipate using the current period of weakness to rebuild equity weightings,” Tristan Hanson, manager of asset allocation and strategy at Ashburton, said in a note.
According to Thomson Reuters data, third-quarter earnings of companies on the S&P 500 index .SPX have contracted at the rate of 15.5 percent so far, better than the 27.3 percent contraction posted in the second quarter.
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Fourth-quarter earnings are expected to swing sharply back to growth of 228.1 percent — followed by an expected 38.1 percent expansion in the first quarter of 2010.
Q3 earnings have generally surprised on the upside, with 81 percent of firms beating expectations. And this generally upbeat earnings picture is offering investors to buy once again after the setback.
Hanson said that markets are still experiencing the sweet spot — benign economic growth and interest rates — and while prolonged low interest rates are sustainable, authorities will make sure they remove stimulus very gradually.
“Given how far Western economic output is below potential, they are likely to move gradually, mindful of avoiding a shock to interest rate expectations that could destabilize financial markets and put recovery at risk,” Hanson said.
“The ‘sweet spot’ will not last forever. However... the general backdrop for financial markets is likely to remain relatively benign for some time to come - a global recovery is underway and monetary policy will remain accommodative.”
As the October setback proves to be just a minor one, investors might need to prepare themselves for a major consolidation sometime next year.
Jeremy Grantham, chairman of U.S. money manager GMO, warns that the pause is likely to have been pushed back to early next year, with disappointing economic and financial data revealing the fundamental, long-term difficulties the economies are facing — such as pressure on profit margins.
“Risk-taking has come roaring back. It is hard for me to see what will stop the charge to risk-taking this year... Price, however, does matter eventually,” he said in a note to clients.
He reckons that fair value on the S&P stands about 860, compared with the current level around 1066.63.
“I would still guess that before next year is out, the market will drop painfully from current levels.”
And between the bulls and bears, there are those who feel that much of the policy horizon is already well priced into assets that market activity will be limited before 2010.
“Generally monetary policy is as expansive as it can be in many countries... It’s fairly priced in that interest rates are going to stay low and they have no plans to reverse quantitative easing in the near future,” said Zsolt Papp, economist at KBC.
“For fund managers who have done very well in this rally since February/March they are considering to lock in some profits. They are not going to be very active for the rest of the year.”
Editing by Ron Askew