Making sense of the market's new normal

In some ways, thanks to the credit crunch, this market is unlike any other. But long-term indicators can still be illuminating

These are odd times for the markets. Even those of us who have argued that equities are likely to perform well, given that the rotation from bonds to equities will be a dominant theme for the next few years, will be impressed by the way in which share prices worldwide have managed to push on upwards.

Click HERE to view graphic

It is mainly symbolic that the Dow Jones industrial average should reach its all-time high this week, for the Dow includes only 30 shares and is unrepresentative of the market as a whole, but symbols affect confidence, and this new peak is both a reflection of that confidence and a driver of it.Notwithstanding the fears about the US "fiscal cliff", the slump in the eurozone economies, the Italian elections, and all the other stuff around, there seems to be a sense that the worst is really over. Growth will probably be sustained worldwide – and if it isn't the central banks will carry on printing the money.

At least, that is the mood of the moment. It could change. At the moment there is a positive feedback loop, in that higher share prices reduce the deficits of company pension funds, make it easier to raise new capital and thereby stimulate investment, and, at the margin, boost consumer confidence and hence final demand.

But anyone who notes that previous highs for the FTSE 100 index were reached on 31 December 1999 and 15 June 2007 will be aware that market enthusiasm is no assurance of further economic growth. On those two occasions it was quite the reverse. Early in the growth phase of an economic cycle a strong equity performance does indeed create positive feedback. Late in the cycle it is a signal that the end of the boom is in sight. Where are we now?

Common sense says that the present growth phase is, to put it mildly, immature. Some would say it is non-existent, but that rather overemphasises the position of Europe, for most of the rest of the world is growing decently. But however you look at it, the fact remains that there is plenty of spare capacity in most major economies, and in some of them a huge amount of spare capacity. So growth ought to be able to continue, and the mainstream expectation of a gradually strengthening expansion makes broad sense.

That does not, of course, necessarily mean that share prices will strengthen too, and to catch some sort of feeling for the mood of the equities markets worldwide I have been looking at some long-term indicators.

The first of these is not so much an indicator as a guide to strategy. It comes from Simon Ward at Henderson, who has devised a very simple investment rule-of-thumb. You look at annual real money growth in the G7 economies and see if it is rising faster or slower than the growth of industrial production. If it is faster, that suggests there is excess money around and you buy equities. If it is slower, you switch to cash and wait. There is one little tweak to the strategy in that the early phase of excess liquidity is often associated with weak output – central banks are printing the extra money in response to that weakness – so you wait for six months after the initial switch to excess liquidity before getting back into the market.

You can see the long-term results of such a strategy in the first graph. There were long periods in the 1970s and 1980s when you would have stayed in cash, and another such period in the run-up to the crash of 2008. You might miss out on the tops of the booms, but you avoid the worst of the slumps. At any rate, world stocks have risen by about a third since the last "buy" signal in September 2011, and there is still a liquidity surplus now, which suggests that the market has further to go.

The other indicators have been developed by Chris Watling at Longview Economics. There are number of these, and it would be nice to say that they all point to further rises in the markets. Unfortunately they don't; or rather, they are mixed.

Taking US data, some, such as the equity momentum indicator shown in the middle graph, are close to buy levels. But there is a sell signal from the optimism of professional share advisers: when they are optimistic, as they are now and have been for several months, you should do the opposite and sell. I rather like the idea that the professionals are usually wrong, even if recently they seem to have got it right.

At any rate, Chris Watling's view is that positive news from the US and the prospect of a return to growth in Europe in the second half of this year should underpin equities for a couple of months more, a view supported by one of the oldest of market adages, the first part of which is that one should "sell in May and go away".

The right-hand graph shows the average monthly return on of the S&P 500 since 1985. As you can see, the March/April/May period tends to be a good one for shares, the summer is uneven, and then things pick up from October onwards. That would seem to validate the second part of the adage, "stay away till St Leger Day", the last flat race of the season this year being on 14 September. That particular rule did not work last year, but the notion that spring is generally positive for shares seems reasonable enough.

The commonsense reaction to all of this is that while no one can possibly know how markets will move, the present strength of equities is not ridiculous in the way that the strength of the bond market was last summer. You can make a decent economic argument in support of the recovery and you can make a decent case for the positive feedback loop. My own feeling is that we are in the early stages of a return to normality. It won't be the same normality as the long boom from the early 1990s through to 2008, but it will be a cyclical upswing – albeit a scruffy one. Against that background the markets sort of make sense.

News
A Brazilian wandering spider
news

World's most lethal spider found under a bunch of bananas

News
people
Arts and Entertainment
Tim Wonnacott dancing the pasadoble
TVStrictly Come Dancing The Result
Sport
Mario Balotelli pictured in the win over QPR
footballInternet reacts to miss shocker for Liverpool striker
PROMOTED VIDEO
News
ebooksAn unforgettable anthology of contemporary reportage
Arts and Entertainment
BBC's Antiques Roadshow uncovers a TIE fighter pilot helmet from the 1977 Star Wars film, valuing it at £50,000
TV

TV presenter Fiona Bruce seemed a bit startled by the find during the filming of Antiques Roadshow

News
people

Comedian says he 'never laughed as hard as I have writing with Rik'

Sport
Steven Caulker of QPR scores an own goal during the Barclays Premier League match between Queens Park Rangers and Liverpool
football
News
i100
Life and Style
tech
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Operational Risk Manager - Asset Management

£60,000 - £80,000: Saxton Leigh: Our client is an leading Asset Manager based...

Project Coordinator - 12 month contract

£27000 - £32000 Per Annum: Clearwater People Solutions Ltd: Our large charity ...

IT Operations Manager - London - £55,000

£50000 - £55000 per annum + bonus + benefits: Ashdown Group: IT Relationship M...

Banking Solicitor NQ+

Highly Attractive Salary : Austen Lloyd: NOTTINGHAM - BRILLIANT FIRM - You wil...

Day In a Page

Oscar Pistorius sentencing: The athlete's wealth and notoriety have provoked a long overdue debate on South African prisons

'They poured water on, then electrified me...'

If Oscar Pistorius is sent to jail, his experience will not be that of other inmates
James Wharton: The former Guard now fighting discrimination against gay soldiers

The former Guard now fighting discrimination against gay soldiers

Life after the Army has brought new battles for the LGBT activist James Wharton
Ebola in the US: Panic over the virus threatens to infect President Obama's midterms

Panic over Ebola threatens to infect the midterms

Just one person has died, yet November's elections may be affected by what Republicans call 'Obama's Katrina', says Rupert Cornwell
Premier League coaches join the RSC to swap the tricks of their trades

Darling, you were fabulous! But offside...

Premier League coaches are joining the RSC to learn acting skills, and in turn they will teach its actors to play football. Nick Clark finds out why
How to dress with authority: Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear

How to dress with authority

Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear
New book on Joy Division's Ian Curtis sheds new light on the life of the late singer

New book on Ian Curtis sheds fresh light on the life of the late singer

'Joy Division were making art... Ian was for real' says author Jon Savage
Sean Harris: A rare interview with British acting's secret weapon

Sean Harris: A rare interview with British acting's secret weapon

The Bafta-winner talks Hollywood, being branded a psycho, and how Barbra Streisand is his true inspiration
Tim Minchin, interview: The musician, comedian and world's favourite ginger is on scorching form

Tim Minchin interview

For a no-holds-barred comedian who is scathing about woolly thinking and oppressive religiosity, he is surprisingly gentle in person
Boris Johnson's boozing won't win the puritan vote

Boris's boozing won't win the puritan vote

Many of us Brits still disapprove of conspicuous consumption – it's the way we were raised, says DJ Taylor
Ash frontman Tim Wheeler reveals how he came to terms with his father's dementia

Tim Wheeler: Alzheimer's, memories and my dad

Wheeler's dad suffered from Alzheimer's for three years. When he died, there was only one way the Ash frontman knew how to respond: with a heartfelt solo album
Hugh Bonneville & Peter James: 'Peter loves his classic cars; I've always pootled along fine with a Mini Metro. I think I lack his panache'

How We Met: Hugh Bonneville & Peter James

'Peter loves his classic cars; I've always pootled along fine with a Mini Metro. I think I lack his panache'
Bill Granger recipes: Our chef's heavenly crab dishes don't need hours of preparation

Bill Granger's heavenly crab recipes

Scared off by the strain of shelling a crab? Let a fishmonger do the hard work so you can focus on getting the flavours right
Radamel Falcao: How faith and love drive the Colombian to glory

Radamel Falcao: How faith and love drive the Colombian to glory

After a remarkable conversion from reckless defender to prolific striker, Monaco's ace says he wants to make his loan deal at Old Trafford permanent
Terry Venables: Premier League managers must not be allowed to dictate who plays and who does not play for England

Terry Venables column

Premier League managers must not be allowed to dictate who plays and who does not play for England
The Inside Word: Brendan Rodgers looks to the future while Roy Hodgson is ghost of seasons past

Michael Calvin's Inside Word

Brendan Rodgers looks to the future while Roy Hodgson is ghost of seasons past