Animal spirits – that was Keynes's resonant expression to describe that particular form of optimism where investors put aside their rational fears in the hope of gain. This is picked up in the title of some new research by Fidelity Worldwide Investment, the fund managers, that analyses the changing mood of the global business community, but it was given a twist, for the full title is A return to animal spirits, a return to fundamentals. So maybe the spirits are not so irrational after all.
The research is a good place to start for those of us who are trying to calibrate the burst of enthusiasm that is sweeping through the developed market economies at the moment. There is certainly plenty of enthusiasm around. Global trade is rising and Western investment is picking up. We have the S&P 500 share index hitting all-time highs and London house prices up 18 per cent year on year. There are rising orders for manufactured goods in the US and good job-creation numbers. And as a counter-indicator, Italian bonds are the best-performing ones so far this year, with 10-year debt yielding 3.2 per cent, the lowest for eight years. There was even a story yesterday that they are being regarded as a "safe haven" for funds. When Italy is deemed a safe haven, animal spirits have indeed returned.
This string of stories is given shape by the Fidelity research. Its core message is that companies are beginning to want to put their cash to work by stepping up their investment plans. The graph shows how 43 per cent of the firms polled are more confident than they were a year ago and only 19 per cent less so. Expectations for capital spending are rising, mergers and acquisitions are expected to pick up, and the overwhelming majority of companies expect dividends either to be maintained or increased.
So all is pretty positive. There are sectors that are expected to be weak, such as raw materials, and inevitably worries, for example about energy costs. But there is also an awareness that some of the headwinds that have faced business in the developed world may be lessening. Thus there is little concern about rising wage costs in the developed world but an acute awareness that earnings in China are shooting upwards. The balance of advantage, which had seemed so adverse a couple of years ago, is tipping back towards the West.
Common sense has, however, taught us to be cautious whenever animal spirits appear to take hold. US equities are now on a price-earnings ratio of 17.4 per cent, well above the long-term level. To justify this needs a continuing flow of strong earnings. Here in the UK we have been more cautious, with the FTSE 100 index well short of its past peaks, though if you look at UK shares in dollar terms they have done rather better, with the pound touching $1.68 yesterday before falling back. Remember the FTSE 100 represents companies whose main business prospects are determined by the global economy, not the British one. It is a global equity index that happens to be denominated in sterling.
So how might this burst of animal spirits look in a long, historical context? I have been perusing some work by Pyrford International, the fund managers, who are quite cautious.
Their starting point is the very long run return on equities as calculated in the London Business School/Credit Suisse report on investment going back to 1900.
UK equities had a total real return (ie capital gain/loss plus dividends reinvested, deflated by consumer prices) of 5.3 per cent. US equities did a little better, 6.5 per cent, and Australian equities did best of all, returning 7.4 per cent.
That period did, of course, encompass two world wars, but even if you look instead at the past 50 years, 1964 to 2013, the total returns are not so different: 6 per cent in the UK, 5.8 per cent in the US, around 5 per cent in Germany, France and Canada, and 5.5 per cent in Australia.
Seen in this context, the surge in US share prices, up 179 per cent from the low in March 2009, looks a bit of an aberration. Pyrford notes that profits currently account for a much higher share of GDP than historical averages and are pretty bearish for equities on a five-year view, and very bearish for bonds.
The big point here is that markets are beginning to price in, if not a long boom, at least a long period of stable and above-trend growth. Goldman Sachs has done some work arguing that the so-called great moderation (less marked booms and less deep troughs), which ran from about 1980 to 2007, may already have returned. Certainly the past three years have seen steady growth in the US and we now appear to be seeing it here in the UK. But we have to get monetary and fiscal policy back to normal and the transition from ultra-cheap money to normal interest rates will be very fraught.
There's the nub: are these animal spirits the result of a genuinely better industrial outlook in the West or are they the creation of the central banks printing shedloads of money? Of course, it must to some extent be both. My instinct is that until a year ago the main impact of ultra-loose monetary policy was on asset prices rather than real output, but now, certainly in the US but also here in the UK, it is boosting real output. That optimism in Fidelity's analysis mirrors similar upbeat attitudes in surveys of industrial and commercial opinion. What we need is more of the animal spirits among corporate investors and a bit less of them among financial investors. But meanwhile, maybe we should just be grateful that the corporate world is getting its mojo back.