Why investors are optimistic, and what they ought to worry about
INVESTORS have entered this year in a buoyant mood. After global equities returned 18% in 2006, many stockmarkets have started 2007 either at record highs or close to them.
Two factors have fuelled investors' optimism. The first is the slightly vague notion of liquidity (see article). There is no universally agreed definition of this concept; best to say you know it when you see it. What is clear is that there is a lot of it about. Investors have felt sufficiently flush with cash to buy high-risk assets, such as junk bonds or commodity futures. Credit has been plentiful for those who need to borrow.
The second factor is corporate profits, which have risen faster and for longer than anyone expected a few years ago. Companies have used their cash to buy back shares, supporting the stockmarket, and the high level of profitability has reduced defaults, helping bonds.
The bullish trends are clearest in the private-equity industry, which has some $300 billion of cash ready to spend, according to Morgan Stanley. Liquidity explains why this business has so much cash; and companies' fat profits (along with low interest rates) explain why private-equity houses are so keen to buy them.
So is the world experiencing another bubble, akin to the one that popped so spectacularly in 2000? Not yet. The four-year-old bull market has been unusual, in that share prices have been pushed higher by rising profits rather than higher ratings. As a result, many analysts think shares are still undervalued, especially relative to government bonds. Nor has the bull market been accompanied by any mania among retail investors, such as the “day trading” fad of the late 1990s.
It is thus not difficult to imagine that financial markets can stay buoyant for a while yet. Investors will be reluctant to sell shares if they believe takeover bids are imminent, especially when the returns on government and corporate bonds are so low by historical standards.
Bulls will also take heart from the ease with which markets have shrugged off so many worries in recent years—high oil prices, the American current-account deficit, terrorism. Those who sold in haste have repented at leisure. Figures over Christmas, showing that home sales were picking up, have helped investors put aside the most recent cause for concern, that the American economy might be hit by a collapse in the housing market. January's rebound in a widely watched survey of manufacturers will have the same effect. And even if the economy falters, investors believe they have a “get out of jail free” card in the Federal Reserve which, having raised rates all the way from 1% to 5.25%, now has scope for a cut.
Reasons to be careful: one, two, three
However, the moment when investors are most complacent is also the moment of greatest danger. Merrill Lynch's survey of global fund managers, conducted in December, showed that investors were expecting slightly slower growth in GDP and profits this year, but were not worried about either recessionor inflation. Most therefore had an above-average weighting of shares in their portfolios. Meanwhile, a poll of Wall Street strategists found that not a single pundit was predicting that American shares would fall this year. And measures of volatility (for shares, bonds or currencies) have been strikingly low.
This sangfroid could be tested by several threats. First, the share of corporate profits in American GDP is already at its highest since 1950. Analysts are blithely assuming they can keep rising. Perhaps globalisation has shifted the balance of power firmly in favour of the corporate sector and away from labour. But workers have votes and may demand the balance be shifted back, either through taxes or trade barriers.
Second, the American economy may not follow the benign path that the consensus assumes. The housingmarket's downswing may not yet be over; and its weakness could prompt consumers to increase their ultra-low saving rates, cutting into demand. Alternatively, growth and inflation may well turn out to be strong enough to persuade the Fed to leave rates unchanged.
Finally, there are the credit markets. The creation of new instruments, such as complicated derivatives, probably makes the financial system stronger in the long run, by ensuring risk is better priced and more widely distributed. But some of these instruments have yet to be tested by a severe recession or a big corporate default. If most people have made the same bet (that risky assets will outperform and that volatility will stay low), there could be an almighty scramble for the exits when the trend changes.
Bull markets are remarkably resilient. But it would be surprising if one of those threats did not cause confidence to wobble at some stage in 2007.
Sunday, March 2, 2008 At： 3/02/2008 01:00:00 AM by Joyce.gardner
Why investors are optimistic, and what they ought to worry about
At： 3/02/2008 12:42:00 AM by Joyce.gardner
BAN KI-MOON, the little-known South Korean who took over command of the United Nations this week from Kofi Annan, lobbied hard to get the job. One wonders why. The secretary-general earns a good salary and gets a pleasant apartment in Manhattan. But the UN is derided by much of the media as divided, bloated, corrupt and impotent. It looks incapable of dealing with the daunting problems of today's world. These include the disintegration of Iraq, stalemate in Palestine, slaughter in Sudan, a new war in the Horn of Africa, global warming and a rush by the likes of Iran and North Korea to acquire nuclear weapons. The secretary-general is the UN's public face and takes the rap for its failings. But he is the servant of an often divided Security Council and has limited power of his own. In many respects this is the job from hell.
In 2005 Mr Annan tried to reform the UN and was thwarted (see article). It would nonetheless be a mistake to give up on the organisation. There are two reasons for this. One is that the UN already does a far better job than it is given credit for. The second reason is more surprising. Although the world looks to be in a state of dangerous disarray, some aspects of today's global politics make this a good moment for the big powers to work more closely together. If they seize the chance they may be able to breathe fresh vitality into the world body and restore some of the high hopes of its founding charter.
Where it fails, and where it works
To say that the UN is doing better than people think is not to say that it is perfect. Far from it. For the past several years, for example, a vast and systematic atrocity has been taking place in Darfur, the western province of Sudan. Some 300,000 civilians have died and more than 2m have been put to flight by government-inspired militias. The United States has called it genocide, and the Security Council has passed solemn resolutions. But the council is divided and an oil-dependent China has so far been unwilling to allow forceful intervention in Sudan's sovereign affairs. So the murder continues, as though the world had learned nothing from its shameful failure to stop the Rwandan genocide of 1994.
The inaction in Darfur is deplorable. But look closer at Sudan. In the south, UN forces have since 2005 been keeping the peace after the end of a separate and even bloodier civil war that had lasted for decades. In Sudan's stricken areas, and elsewhere in Africa, the UN's World Food Programme feeds millions. Indeed, around the world as a whole, some 30m people in 50 countries are reckoned to depend on UN relief agencies for their very survival. In Congo one of the largest UN forces ever assembled has just overseen the transition to free elections in another vast country emerging from decades of war. But that is just one of 18 different missions, in which about 100,000 UN peacekeepers are deployed.
These numbers tell you that although a divided Security Council can paralyse the UN, as before the Iraq invasion of 2003 and over Darfur now, the council is not always divided. Moreover—and this is the surprising bit of the argument—there is reason to hope that the council's five veto-wielding permanent members are entering a period during which they may see the point of whittling away more of their differences.
A scan of dire headlines might undermine this optimism, but a little perspective supports it. Compared with most of the 20th century, today's big powers have few head-on conflicts. America no longer confronts a Soviet Union. Russia is newly assertive, but is focused mainly on its own near-abroad. Rising China may threaten America's future as sole superpower, but the two countries' economies are interlocked and both need good relations. There is competition, of course, but the Chinese push into Africa, say, is a commercial affair rather than a collision of empires of the sort that took place before the first world war, when European powers scrambled for colonies.
A new type of world disorder
Today's disorder stems not so much from conflicts between the big powers as from other problems all say they want to solve: failed states, terrorism, proliferation and the chaotic Middle East. Their priorities and tactics differ, but that still leaves room to co-operate. For example, it has taken an age to sign up Russia and China for action against Iran's nuclear programme. But now they have signed: the Security Council is imposing sanctions on Iran for enriching uranium. If Iran carries on regardless, the council may once again divide between those who will and those who won't take military action. But an Iraq-entangled America shows little appetite for new battles. And although the superpower is often the UN's harshest critic, it has come again to see the point of turning to the UN for help with problems—be they keeping the peace in Lebanon or saving lives in Darfur—it finds hard to solve alone.
If everything in the UN's garden is lovely, what is the case for reforming it? Part of the answer is that the organisation needs to run faster just to stay in the same place. At present it enjoys a good deal of legitimacy. But at some point that will fade unless the Security Council takes at least Japan, India, Brazil, Germany and an African country into permanent membership, so that it reflects today's world rather than the one of 1945. It also needs some military resources of its own if it is to cope with the ever-growing demand for peacekeeping. Right now a small battle-ready force, raised by the UN itself and not by any Western or neighbouring government, is exactly what is needed in war-torn Somalia (see article).
In the meantime, the permanent five could make the world safer and more orderly by showing a greater willingness to work together using the existing structure. They are not going to turn the UN into a world government, as some Utopians would like. America in particular will not consent to being tied down like Gulliver, especially where it thinks its security is at issue. But at a moment when their rivalries are small, yet most are anxious about the same range of transnational threats, all the big powers ought to see the benefit of making better use of the potential for joint, lawful international action that the UN uniquely provides. If not now, when?
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