January 25, 2013

LONDON, Jan 18 Only four weeks into the new year, ebullient world stock markets have clocked up gains of more than four percent, so already there are murmurs about whether it's too much, too soon.

Put another way, if global equities were to repeat January's stellar performance every month of this year, then we would be in for returns of more than 50 percent in 2013.

That's not technically impossible, but it is highly unlikely given a still stodgy economic and company earnings backdrop despite all the evidence of a global cyclical upswing.

MSCI's benchmark world index has never put in annual gains of more than 32 percent over the past 25 years.

So is now the time for hesitation and a healthy pause for breath or an outright correction?

Investors' new-found gusto for riskier plays has stoked an appetite for everything from euro sovereign bonds and emerging market debt and equity to even the preference for small cap over big blue chip stocks.

Financial volatility gauges -t o the extent they represent investor fears - all continue to plumb their lowest levels in five or six years.

But this recent exuberance is unnerving policymakers - many of whom strove for so long to rekindle these very "animal spirits" but now fret about the seeming disconnect between the spluttering real economies and a financial world fueled by the cheap money central banks themselves have created.

"A combination of a weak recovery, and people searching for yield in ways that suggest that risk isn't fully priced, is a disturbing position," Bank of England Governor Mervyn King said.

"There is complacency and it is very dangerous," Angel Gurria, the head of the Organisation for Economic Cooperation and Development, told the World Economic Forum.

Jaime Caruana, general manager of the Bank for International Settlements, chimed in with: "We need to pay attention to the misvaluation of risks, the misassessment of risk. I think we need to monitor that."

So some strategists think it may well be time for some stock-taking, in more ways than one.

"The dichotomy of a low level of business confidence and many asset markets at or close to their most risk-positive levels - since 2007 - is stark and potentially aiding in some near-term consolidation," Barclays warned clients on Friday.

MARKET FILLIPS

But many caution about confusing short-term price fillips with a more considered rethinking of potential long-term returns in historically undervalued and under-owned equity.

That's especially so if systemic stability fears at least have receded, leaving the perceived safety 'core' government bonds in the United States, Germany or Britain and other euro crisis havens, such as the Swiss franc, hyper-expensive historically. These have all retreated over the past few weeks.

Bank of America-Merrill Lynch, whose January fund manager survey showed the first overweight in global bank stocks in 6 years, says there might be an argument for a "pause for breath".

"It is possible we get a consolidation at or near current levels but I don't see ingredients for a sharp sell-off given positioning and valuations," said John Bilton, European investment strategist at BofA-ML.

And whether or not you believe in the so-called "Great Rotation" back to equities from bonds by long-term investors such as pension and insurance funds, the draw of dividend-enhanced equity returns over time is becoming more obvious.

Standard Life Investments strategist Andrew Milligan points out that while stock markets may still be shy of pre-crisis peaks, total return indices on the UK's FTSE 100 and S&P 500 showing market performance when dividends are reinvested hit all-time highs last September.

And cumulative returns of 100 percent on UK equities since the trough of March 2009 are three times that of British gilts.

"If accompanied by a wider acceptance that some of the more arduous repercussions of the global financial crisis are fading, these total return indices may signal the start of a more important shift in the post-crisis return environment," he said.

But where do markets go shorter term?

One of the reasons for the January burst of life is that many of the potential new-year pitfalls never materialised.

The U.S. budget showdown has been defused for now and deadlines keep getting put back. The earnings season has been benign so far, despite an outsize reaction to Apple's results this week. And Europe's sovereign funding worries have proven wide of the mark to date too. Buyers have flooded back to Spain and even bailed-out Ireland and Portugal.

China's economic data confirms a decent rebound and global business surveys suggest about a 3 percent annualised growth of industrial output in the current quarter, according to JPMorgan.

AHEAD

So what can go wrong? A glimpse at the calendar would tell you to watch out for next month's Italian elections. But the buoyant performance of Italian debt markets this year suggest some comfort with the most likely outcomes there at this stage.

The biggest market hurdle is the likely over-inflated expectations themselves. Citi's U.S. economic surprise index -measuring data that's above or below consensus forecasts - tipped into negative territory this week for the first time since last summer despite a broadly positive slew of reports.

For many, the index speaks more about the scale of rising expectations - typically discounted into market prices - than any threat per say to the real recovery.

Even though the converse is true for the euro zone, suggesting consensus gloom was overdone, the fuel of positive "surprises" is important even if long-term strategic buying limits any price retreat.

The start of the fourth quarter earnings season tells a story too. With almost a quarter of the S&P500 firms reported, the numbers showed 68 percent beat forecasts - ahead of the 65 percent average of the past four quarters.

While market euphoria based on expected earnings growth of less than 3 percent seems odd, eyes remain on persistent double digit growth forecasts for 2013 as a whole. And if that seems fanciful, there's at least the hope that near zero growth in the third quarter of last year was the nadir for the cycle.

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