x Abu Dhabi, UAEFriday 28 July 2017

For world markets, the sky's the limit for bottoming out

History shows that markets don't shuffle sideways forever. The question is: will they waltz forwards or slump backwards?

If you were hoping to make money from another year of rising stock markets, you will have been sorely disappointed so far.

Markets have being doing the sideways shuffle for the past six months, performing plenty of vigorous moves, but ending up in exactly the same spot.

History shows that markets don't shuffle sideways forever. At some point, they cut loose. The question is: will they waltz forwards or slump backwards?

Investors have a tough call to make. They don't know if now is a great opportunity to buy shares on the cheap, or if it's their last chance to flee the stock market before the next crash. If it helps, the experts don't know either. Actually, that doesn't help at all.

It is famously said that stock markets climb a wall of worry and right now, that wall looks steep and slippery, says Tom Stevenson, the investment director at the global fund manager Fidelity International.

"We have the threat of a default in Greece and contagion throughout the eurozone," he says. "The US has yet to start tackling its debts and growth is slowing. Emerging markets such as China and India have reached a watershed and are struggling to keep a lid on inflation. So there is plenty to worry about."

But it isn't all fear and worry. Mr Stevenson names two good reasons why stock markets might bounce back as autumn approaches: strong company earnings and attractive share valuations. "Even in the West, company earnings are growing, while shares look reasonable value by historical measures. A decade ago, the average company quoted on the benchmark FTSE 100 index was valued at 20 times its earnings; now it is just 11 times. So shares do look relatively cheap."

Investors have been holding their breath for the past six months as they balance macroeconomic woe against microeconomic joy. "The negatives are sovereign debt, rising inflation and dwindling growth. The positives are corporate earnings and valuations," Mr Stevenson says. "Weighing one against the other, I am cautiously optimistic."

Stock markets may look rocky, but Mr Stevenson warns that the alternative - leaving your money in cash - doesn't guarantee you an easy ride either. "Cash is safe, but the interest paid is typically well below the inflation rate, so its value is actually falling in real terms. Equities have a better chance of beating inflation, but it could be a bumpy road for several years."

The Greek parliament may have approved its austerity package on June 29, but the tragedy is set to rumble towards its inevitable conclusion.

Greece is likely to be plunged into another crisis within the next 12 months - possibly sooner, says Stuart Thomson, the chief economist at Ignis Asset Management. "Adding debt on top of debt will ultimately be self-defeating," Mr Thomson says. "We expect Greece to remain a problem until the inevitable default takes place. The next IMF tranche of bailout money is due in September. That is a likely source of trouble."

Mr Thompson says a Greek default is "a virtual certainty".

"The austerity package will only prolong the recession, boost unemployment and raise the deficit even further. Kicking the can down the road, as the EU has been doing for months, is only going to make matters worse."

The only question is whether it will be an orderly or disorderly default. "A disorderly default would result in immediate bankruptcy of the Greek state and most likely exit from the single currency. The resulting contagion would be worse for Portugal, Ireland, Italy and Spain."

It wouldn't do much good for the US, either. Its banks and insurers have an estimated US$100 billion (Dh367bn) exposure to Greece. If the EU's game of brinkmanship fails, contagion could be global. No wonder people are talking about another Lehman Brothers moment. No wonder investors are nervous.

Remember what the collapse of Lehman Brothers, the investment bank, did to share prices in the autumn of 2008? A eurozone meltdown could make that look like a dress rehearsal for the big one. At that point, the sideways shuffle could end, leaving investors to face the music.

Greece frightens stock markets, but the US is a far scarier beast, says Gaurav Kashyap, from the Dubai-based online trading brokerage Alpari ME DMCC. "The problems in Greece have been priced into stock markets. Providing Italy and Spain don't get dragged into the crisis, the trouble should ease. My big concern is the US, where the figures don't look good. Unemployment and inflation are both up. Manufacturing is down, output is down and consumer confidence is down. It is a major worry."

When the US faced similar problems last year, Ben Bernanke, the Federal Reserve chairman, responded with a $600bn blast of virtual money printing, known as quantitative easing, or QE2. Stock markets and commodity prices fizzed on the sugar rush, but the effect wore off long before QE2 ended on June 30.

The $1 million question now is: will the Fed give us QE3? "Bernanke is saying nothing right now, but I can't see how the US can get away without it. The Fed will have to take measures to prop up the staggering US recovery," Mr Kashyap says.

Without QE3, markets will struggle and so will the US economy. "If the Fed does approve another round, and I think it must, we can expect another rebound in stock markets and commodity prices. Greece is just a sideshow. The US is the main event," Mr Kashyap says.

A $14.3 trillion main event, to be precise. That's the size of the US debt ceiling, which the country is expected to hit as soon as August 2.

If Congress fails to lift the ceiling by that date, it could trigger a US default for the first time in its history. You don't want to have your life savings in stocks and shares if that happens.

The Republicans walked out of recent talks on the debt ceiling and if the political wrangling continues right up to the wire, markets are likely to become ever more nervous.

If the US misses any debt repayments after the August deadline, the Standard & Poor's ratings agency has already warned that its AAA credit rating will be slashed.

Even if it avoids that grisly fate, the US will struggle to grow. House prices are still falling, inflation is rising and the country's deficit, now running at 10 per cent of GDP, hasn't been tackled at all. The global economy needs a buoyant, happy US consumer and it isn't getting it.

Investors exhausted after holding their breath for the past six months may have to hold it a few months longer.

Far above their heads, central bankers across the world are performing a delicate balancing act, says Spencer Lodge, the regional director at the financial brokerage PIC Devere in the UAE. "In the West, they are keeping interest rates as low as possible in a bid to sustain growth, while desperately hoping this doesn't tip their economies into hyperinflation."

If they pull off this feat, investors could reap the rewards. "Many companies have restructured since the recession, streamlining their businesses and boosting profits. The recovery will take time and remain bumpy, but in the long term, the outlook for stock markets is promising," Mr Lodge says.

So what should investors in the UAE be doing with their money now?

Until the problems in Greece and the US are solved, one way or another, markets will continue to lack direction, says James Thomas, the regional director at Acuma Wealth Management in Dubai. "For the next few months, I don't see anything except more sideways movements, amid plenty of volatility."

He is telling his clients to stay invested, rather than pull their money out of stock markets. "We always profile our investors' attitude to risk and warn them that shares and funds can fall as well as rise. If you are investing for the medium to long term, then relatively short-term problems are not quite as important. If you have a well-diversified portfolio, spread across different regions and asset classes, then you should be spared the worst."

Now may be a good time to set up a regular savings plan, to drip-feed money into the stock market every month. "This is a good way to play volatility. If markets fall, your monthly contribution buys more units at the lower price. This can work in your favour, as long as markets have rebounded by the time you finally cash in on your investment," Mr Thomas says.

Timing the stock market is almost impossible, but if you are investing a lump sum, it may be best to wait until the market is in a slump, rather than a rally. That way, you can get more for your money. If the current volatility continues, you should spot plenty of buying opportunities.

The sideways shuffle won't go on forever. At some point, stock markets will strike up a different tune - good, bad or indifferent. Will you be on the dance floor when they do?

pf@thenational.ae