America’s Standard and Poor’s Index is up 27% in five months and has doubled in the last two years (from a low in early March, 2009 of 666.79).
European markets hit 29 month highs this week on a number of occasions, commodity prices like gold, copper and cotton have hit all time highs and many other markets are zooming higher.
As we have seen that has made big global and regional funds managers very confident, complacent say some cautious commentators.
The AMP’s chief strategist, Dr Shane Oliver examines the background to where markets currently find themselves.
Improving confidence in the global recovery has seen mainstream global share markets post strong gains since mid last year.
However, many fret that it is unsustainable with high unemployment, high public debt and unsustainably easy monetary policy hanging over advanced countries and emerging markets increasingly subject to inflationary pressures.
Cyclical recovery has further to go
While, as always, there is lots to worry about, our assessment is the cyclical recovery in shares is panning out broadly as expected and has much further to run.
After a major bear market ends the recovery in shares often goes through several stages: an initial rebound during the first year, a period of correction or consolidation in the second year and then a continuation.
This is illustrated in the table below for Australian shares which shows strong average gains in the first year, typically poorer performance in the second year and then strong gains in the third year.
So far so good with the correction in share markets last year being consistent with this pattern.
Of course, markets don’t always follow a precise 12 month pattern, but if history is any guide this would suggest strong returns over the next six to 12 months.
More fundamentally, the broad cyclical backdrop for shares and other growth trades remains fundamentally positive.
First, share valuations are still attractive. The forward price to earnings multiple for global shares is 12.9 times which is well below longer term averages for the low inflation period.
Similarly, the forward price to earnings ratio for Australian shares is 13 times compared to a longer term average of 14.6 times.
Emerging market and Asian shares are only trading on 11 to 12 times forward PEs.
Second, while some of the heat is starting to come out of emerging countries, leading indicators for the US, Europe and to a lesser degree Japan have moved back up after a soft patch mid last year.
This is evident in business conditions indicators as shown in the next chart.
In fact, the US is leading the charge on this front.
The US ISM business conditions indicators are about as strong as they ever get.
Corporate profits are up strongly and this is boosting business investment.
Various labour market indicators point to a big resurgence in jobs growth and unemployment is already falling.
Finally, US consumers are starting to feel more confident again and this is boosting retail sales.
Similarly in Europe, strength in Germany is more than offsetting weakness in peripheral debt troubled countries.
So there is good reason for confidence in the sustainability of the global recovery.
Third, the liquidity backdrop for shares is very positive with: easy money in the US, Europe and Japan; cashed up corporates starting to undertake takeovers and share buybacks and boost dividends; and individual investors starting to switch back from bonds to shares.
At the moment the latter is particularly noticeable in the US with the record inflows into bond mutual funds of recent years now starting to flow back out into equity mutual funds.
Given the size of the bond inflows in recent years this might have a way to go before it is complete.
If history is any guide and share markets do continue to rise then the same is likely to become evident amongst Australian individual investors.
In fact the US and northern Europe are arguably in the classic “sweet spot” in the investment cycle – with rebounding growth and surging profits but plenty of spare capacity such that inflation is not really a problem and central banks can keep interest rates low and money easy.
This period in the cycle is usually very positive for shares.
Finally, there are no signs of the excesses that normally mark the end of cyclical recoveries in shares.
Inflation is still benign in advanced countries and even in emerging countries it is mainly reflective of higher food prices, not excessive demand.
Prices for assets such as shares and property are still far from being overvalued.
But what could go wrong?
Essentially there are four main areas of concern.
Firstly, there is a risk of a short term pull back in shares. Many technical indicators suggest US shares are overbought and measures of short term investor optimism are at levels that often precede corrections.
However, while there is the risk of a consolidation or a 5% pullback, the positive fundamental outlook outlined above suggests any short term dip should be seen as
