They may know the risks, but reckon they have been overstated or taken into account. In recent months, the main share markets of the world have been in a broadly optimistic mood. They have taken in their stride the civil wars in the Middle East and the political conflict in the Ukraine. They have shrugged off disputes between China and Japan and have assumed the main advanced countries will keep interest rates low to sustain the recovery. So what could go wrong?
The last couple of years saw more investors wanting to own shares in the advanced economies than in the emerging markets area. The mood was very critical of China with fears of banking troubles, property price falls and too much local authority debt. Brazil suffered a bout of inflation and was forced to raise interest rates and slow its economy. Argentina has been hovering on the edge of renewed bankruptcy problems as it wrestles with debt owners who do not appreciate its previous cut in repayments. Russia has fallen out of favour as an energy producer who is in dispute with the European Union, its main customer. More recently, investors have thought that the worst of these problems are now well known and the shares in many of these markets look cheap. China is not about to experience a banking crash. Brazil may get a boost from the World Cup and the forthcoming elections. India has a new government which states its wish to be business friendly.
There is no need for there to be a universal aversion to emerging markets. Different countries have very different prospects for growth, interest rates and inflation. Careful selection of the right emerging markets can make people money. China still looks cheap and the government there is likely to steer the country through a transition to more market influence over economic life, and more service activity to complement the successful industrialisation of the previous administration. We await the full Indian programme with interest.
The biggest headwind for the advanced markets will come in the form of higher interest rates and the end to special monetary creation measures which markets have come to rely on. So far, the UK has weathered the ending of Quantitative Easing (money creation) and is aware that official short term rates will start to rise within the next year. The US market has reached new highs during a period of the Fed reducing, and in the end, eliminating the creation of new money to buy government bonds. In the Euro area, the authorities have carried on cutting interest rates despite the low levels already reached and in Japan the authorities continue to create large quantities of new money. Money policy matters, but does not yet seem to be a cause for major concern as all the advanced country authorities are keener on growth than on higher interest rates.
The Middle East remains a centre of concern, with civil wars in several countries and tensions between Sunni and Shia movements. So far it has not spread into the major oilfields and shut down substantial production. All the time it remains a regional conflict and the oil continues to flow, it should not disrupt share markets, though it is of course of considerable concern for humanitarian reasons. Russia looks as if she has secured what she wanted from the flare up in the Ukraine. The newly elected government there is gradually reasserting control over the recalcitrant east of the country. The dispute has served to highlight much of the EU’s energy vulnerability and may produce policy changes that help in the longer term.
The Euro is still a currency in difficulties. The intense crisis of 2011 is behind us, and it appears the Euro area has ways now of muddling through without serious banking dislocation. However, there is no good solution to the need to transfer larger sums from the richer to the poorer parts of the zone easily, and the banking system is still unable to sustain a decent recovery through private credit. Markets should worry a bit about the high price and scarcity of energy in zone, and the problems with directing the banks.
As often, there is plenty to worry about. There is as yet no one dominant fear to bring the markets crashing down. As always investors need to be eternally vigilant and attentive to changes of mood.
John Redwood is the chairman of the investment committee at Charles Stanley Pan Asset
