Hamish McRae: We are past the worst – but there are still disappointments to come

Economic Life: As long as the world economy has the prospect of further growth, markets have the same prospect
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The Independent Online

It feels like the end of the beginning – the beginning in this instance being the rebound in confidence in share markets and property prices that has taken place since the spring. Both stories have been extensively reported and both have been pretty much global. Share markets have recovered astoundingly everywhere, though in noting that they have risen in almost all major markets by more than 50 per cent, you have to acknowledge it is easier to have a great leap forward if you start from far enough back. As for property prices, though the recovery has been less dramatic and there are vast variations between different markets, as well as between residential and commercial, there are clear signs of an upturn in most places. OK, not Dubai, but most of the rest.

Actually the Dubai experience has itself carried a lesson about market sentiment, for it has had, so far at least, surprisingly little adverse impact beyond the markets most directly in the firing line. It seems to be accepted as a legacy event; something caused by the events of the past year that has belatedly come to light, rather than an indication of what might happen more generally in the future. Outside the Middle East, the UK is arguably the most directly affected by Dubai, yet share prices yesterday morning were within a whisker of their yearly high, before a weaker Wall Street nudged them down again. But if there is resilience, there is also concern. That concern needs to be examined, first as far as share markets are concerned, second with regard to property prices. It is simpler to focus on the UK in both instances but actually the lesson of the past year is that movements in asset prices are pretty much global. The differences are less than the similarities and are of degree rather than direction.

Here in Britain, the big issue in the equity market is the extent to which it has been supported by quantitative easing and consequently what might happen when this programme comes to an end. We don't yet have much of an indication either as to the strategy or timing of the exit, though I think we can safely assume that the Bank will not do anything precipitous. The danger here seems to me to be that there will be a more general loss of confidence in our economic management rather than a loss of confidence in the Bank's policies. In other words the threat is on the fiscal side, not the monetary one.

We do however know that the European Central Bank is moving towards ending its unconventional measures, which though technically somewhat different from those of the Bank, have been broadly similar in aim and effect. As for the Federal Reserve, there are a number of new appointments and resignations in January but I cannot see any significant shift in monetary policy as a result. Monetary policy will remain loose for the foreseeable future, though again, at some stage next year the Fed will have to end its exceptional support.

My working assumption, pulling all this together, is that there will be a gradual end to the exceptional liquidity measures over the next six months. By the middle of next year monetary conditions will have started to tighten. Credit will remain reasonably cheap but the flood of money from central banks on to global markets will have ended. If that is right, then markets will, so to speak, be on their own. The issue then is whether they can sustain their present advance or whether this experience of the past six months will prove a false dawn.

I have been looking at some work by Chris Watling at Longview Economics and the left-hand chart comes from that. He caught the turn in the markets in March, as reported in these columns, so his judgement now needs to be taken seriously. His view is that we are in a cyclical bull market, the longevity of which will depend on the longevity of the economic cycle. Bull markets typically divide into three parts, the initial recovery, a consolidation phase and a third period of gains, maybe lasting several years. We have clearly had the first phase, which may now be drawing to a close. The start of the second phase is typically signalled by expectations of a tightening on monetary policy. If that is right markets might move sideways for some months, creating buying opportunities as they periodically dip. Looking forward a year or 18 months, he expects equities to be notably higher.

Equity advisers were exceptionally pessimistic in the spring, more so than at any stage in recent history. Now they are more optimistic than at any stage. You might think this is a bit of sell signal, on the somewhat cynical principle that the professionals usually get things wrong. It certainly should make us all a bit wary. But actually markets can carry on rising for quite a while against a backcloth of optimism. As long as the world economy has the prospect of further growth, the markets have the prospect of further growth.

My takeaway from all this is that we can say very little about the durability of this bull market because we can say very little about the solidity of the forthcoming growth phase. A period of sideways movement, with some quite severe dips, is very possible. But the big point – that we are in a bull market – remains true.

What about property? It does seem that the giant US market has at last bottomed out and since that is where the global financial disaster began let's welcome that. But let's focus on the UK because that is closer to most of our interests. Here the market is now several percentage points off the bottom and there are a lot of questions as to whether this progress can be maintained. Prices have risen now for most of this year, though activity remains muted by past standards. A good advance indicator of the mood of the market is the balance of buyer inquiries and sales instructions, as reported by the surveyors. Both are positive, which is encouraging, but the surge in buyer inquiries earlier this year has eased back a little.

What do we conclude? Capital Economics, which forecast the severity of the housing downturn earlier than most, thinks that the market is now losing steam, with price rises slowing. It thinks that the combination of a rebalancing between supply and demand, coupled with rising unemployment, will lead to renewed price falls next year.

My own view is that there probably will be a pause in house prices – and maybe a dip – in the coming months, in much the same way as there will be one in equities. There will be a lot of disappointment next year, because not only do we have to wean the country off quantitative easing but we have to make a start on cutting the fiscal deficit. So the headwinds here will be strong and debilitating and there will be some sort of second leg to the downturn. Nevertheless, the turning point is clearly passed. After the dreadful year we have been though, that is a bit of a relief, isn't it?