As an example how sentiment can change towards events, overnight on Wednesday crude oil prices fell by 5% and on Thursday Germany rejected an application by Greece for a loan extension. Equity markets appeared to brush of both pieces of news that on other days may well have shaken confidence. The release of the minutes from the last Federal Reserve meeting may well have had some part to play in the way equity markets equity behaved on Thursday, as the minutes seem to suggest that the Federal Reserve remain cautious of moving too quickly on raising interest rates.
The financial media like to continue to debate the merits and value of equity market valuations. CNBC quoted hedge fund manager Crispin Odey’s view that equity markets are over valued, in response one guest replied that may be the case, but it still provides better value than other asset classes. Valuation is important but we harp back to the point its more important to decide whether companies can grow their earnings in the current environment. History would dictate that, lower fuel costs, low interest rates, low inflation and modest real economic growth is a back drop for companies to grow earnings in, and on that basis equities can continue to support a higher valuation. The challenge will come when the cost of money rises, but at that time hopefully economic growth with have strengthened further. This equity rally continues to remain one of the most unloved in history.
To that point it is worth looking back to 1994, that was the time of the famous quote from Ben Bernanke calling the equity rally irrational exuberance, the S&P was about 400 at the time, also an all time high. Other similarities between now and then, oil prices had just halved and interest rates were starting to rise. This combination eventually led to the bubble of the 2000’s, at that point no more irrational exuberance, just irrational optimism.
One cannot let the ongoing negotiations with Greece pass without comment on the latest developments. The focus on whether it is best for Greece to stay in or leave the euro misses the point in our view. It is not what is best for Greece that the rest of Europe is focusing on; it’s what best for the rest of Europe and the euro. As they are uncertain of the consequences of Greece leaving they believe it is best, if possible, for Greece to remain in the euro. If the rest of Europe were to focus on the what’s best for Greece they may well come to the conclusion that Greece should leave.
What does not want to happen is the debate becomes them or us between Greece and Germany. Should the rest of Europe decide the euro would be better of without Germany rather than Greece that would definitely throw the whole situation in a very new direction.