The recent "rally" of the stock market is not justified by substantial improvements in terms of fundamentals (the most important macroeconomic data), which has inevitably prompted many commentators to question the sustainability of this "Bull Market".
How do you explain this sudden acceleration of the Stock Exchanges? Where are the risks?
It is commonly believed that low interest rates and the enormous mass of liquidity injected by central banks have prompted investors to seek returns first in corporate bonds, then in government bonds and finally in shares.
Some readers might say: "How is this possible, if the macroeconomic scenario hasn't changed much?" and he would be right, but the introduction of liquidity by the Central Banks (quantitative easing) has softened the perception of the main risks of the moment (crisis in the Eurozone, slowdown in the USA and China) and the associated "tail risks".
In fact, if we take a look at the whole Bull Market period starting in the first part of 2009, we notice that the equity markets have behaved quite well even in the presence of systemic risks and the only mini-reversal that has it was in conjunction with the Italian crisis (summer of 2011).
What is the scenario in the short term?
We can endlessly discuss the "distorting" effects of the Central Banks' unconventional monetary policies but the fact is that, in the short term, there are no grounds for stopping injecting liquidity into the system.
According to Mark Kiesel, manager of PIMCO, the Fed and the BOJ (the Japanese Central Bank) are ready to purchase bonds for a total value of $2.000 billion in 2013 and for a few days Europe has also been discussing the possibility that the ECB could start a debt securities purchase plan (apparently asset-backed securities).
In short, liquidity will continue to support all asset classes in the short term.
So how to invest right now?
Even after the recent equity rally, valuations continue to remain affordable overall. If we consider the classic Price/Earnings ratio per share (or P/E) with respect to the long-term value, a commonly used method (but not the only one, of course) to get an idea of the price with respect to a considered value of " Fair Value” tells us that the USA is a market that is still a little below the historical average and the evaluations of Europe and Japan remain even more interesting in relative terms.
In conclusion, that there is a risk appreciation problem there is no doubt, but unfortunately none of us is able to anticipate exactly the timing in which the stock market and the bond market will reverse.
That said, as long as valuations justified buying equities, the market fared quite well with respect to a deteriorating economy, even in environments where systemic risks were substantial. In addition, in the short term there are no signs that allude to an easing of liquidity, quite the contrary.
In short, I wouldn't be surprised to see the market go up again. But keep an eye on the ratings!
