Self-interest and fear: These factors are the main driving forces of stock markets. Self- interest, the economist Adam Smith’s great motivator, is currently running scared. Right now, fear is the dominant sentiment. In the first months of 2014, the fear that the severe winter in the United States could choke off the economic recovery throttled stock markets. At present, the conflict surrounding the future of Ukraine and fears of deflation in the Eurozone are weighing on markets. Fortunately, though, political markets still have short legs. And in the Eurozone, remember that declining inflation does not necessarily mean deflation.
The Eurozone is still far from deflation.
The fear that these factors could cause growth to slump is likely to prove unfounded. On the contrary: Leading indicators point to accelerating economic momentum in the Eurozone and in the United States. The U.S. Federal Reserve Board (Fed) is likely to continue its tapering policy and end its bond purchases by fall. At this point, low interest rates could come into focus. If they rise, bond yields should continue to increase. As a result, 2013 and 2014 could go down in history as the end of the 30-plus-year bull market in bonds.
More and more investors are starting to anticipate this and are moving out of bonds and into stocks. This has already caused stock valuations to climb. A look at past valuation ratios, however, reveals one thing: Equities are not overvalued yet. Moreover, higher growth is likely to trigger an increase in corporate earnings. The so-called “smart money” should underweight bonds that offer lower yields at higher risk—and place its bets on stocks.
The old stock market saying “sell in May and go away” could thus prove wrong this year. Indeed, stock markets could be in for a bumpy climb up in light of the expected rise in interest rates. But market dips could be good buying opportunities. In addition, capital flows indicate that the first investors are resetting their sights on emerging markets. We, however, will remain selective and favor emerging markets that demonstrate little dependency on commodity prices and boast strong fundamentals—self-interest still needs to be balanced with a little caution here.
