Hamish McRae: Why aren't equities sharing the pain?



If the world economic outlook is so bad, why have global equities done, well, not too badly? There is the prospect of another ineffective European summit. The UK economy is supposed to be in recession. The American economy is growing slowly but faces a fiscal cliff at the end of the year. Japan's stagnant economy faces a doubling of its sale tax. China is slowing, as is India. The Brazilian real is plunging… it goes on and on.

Yet UK shares yesterday were within a couple of percentage points of their level at the end of last year. The Dow is well up on that, and actually up on the level of a year ago. The DAX, the main German index, is up so far this year; the CAC40, the 40 largest companies on the Paris Bourse, is only down a little. Indeed, while it has been a glum couple of months for equities generally, they are a long way from the blind panic of the spring of 2009.

You see the point. So what is the explanation – aside from the possibility that they are utterly deluded? There are two broad explanations and there will be a bit of truth in both. One, the "glass half full" explanation, is that seen in the big, global view, business is not doing too badly. The banks everywhere remain under pressure, but non-financial companies, taken as a whole, are still finding areas of profitable growth, and those in difficult sectors are being successful in cutting costs. In the US, they have been particularly successful in using the recession to slim down, while in Europe, they are at least being adult about the plight of the eurozone and doing their contingency planning in case of a break-up. And here in Britain, well, there is some demand for their stuff. Thus, new car sales were up 8 per cent year on year in May.

Given that shares on the major markets are at reasonably low price-earnings ratios – the UK is about 11 at the moment – and given that cash and bonds yield so little, equities seem a reasonable investment.

The other explanation is the "glass half empty" one. It is that the central banks have printed so much money that it has to go somewhere. One of those places is global equities. If, as is quite possible, things get seriously worse in the coming months, the central banks and the governments will bail us all out. If the world economy takes a serious dive, the central banks will print even more money to rescue the system. If the eurozone really looks like breaking up, and that means several countries leaving, not just Greece, then the poor old German taxpayers will be made to stump up. If things really go badly, the paradox will be that notionally risky assets such as global equities might prove less exposed than the perceived safe-haven bonds of Germany, the US and the UK.

It is silly to ascribe some sort of special wisdom to financial markets, for they are, and have always been, merely a mirror of humankind's collective hopes and fears. But there is a difference now from the markets of, say, a decade ago. Now, in our more balanced world, they reflect the views of people in the emerging and the growth markets as much as those of the West. Something like two-thirds of the world's savings come from Asia. So those savers' perceptions are just as important as ours, maybe more so.

The Treasury should be worrying about its future tax revenues

It has not been a good start to the UK's financial year, for far from the deficit coming down, it is actually going up. True, the deficit was projected to fall only slightly this year, with the big reductions coming next year and afterwards; true, much of the deterioration has been the result of higher spending rather than lower revenues; and true, this is only two months' figures. But there is one really worrying figure – income tax receipts – which should give a chilling message to the Treasury. It is that the increases in income tax rates, far from increasing tax revenues, are actually reducing them.

The devil, as so often, is in the detail. Government spending in May was running up 7.9 per cent year on year. That is a lumpy figure and, until we get more detail, we shouldn't worry too much about that, though it does give the lie to all this stuff you read about "the cuts". Revenues were up only 1.6 per cent; disappointing but, on the face of it, understandable given what is at best slow growth. But if you look at the detail of the tax receipts, you see something quite alarming.

The three biggest taxes in terms of revenue are income tax, National Insurance Contributions and VAT. VAT is doing fine: it brought in £9.2bn this May against £8.75bn last year. That suggests that consumption is running up on last year, which, in turn, would suggest that the economy must be growing, too. NICs are also doing fine: they brought in £8.4bn, as opposed to £8.1bn last year, as you might expect since employment is higher now than then. But income and capital gains tax (they are lumped together in the monthly numbers) only raised a little over £9.6bn as opposed to nearly £10.4bn last year.

It is too early to jump out of the window about this. It is only one month's number and the previous month's revenue was up on 2011. But the plain fact remains that taking the first two months together, income and capital gains tax revenues are down on last year. That is a big worry for the future.


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