The Equity markets are failing to price in what is ahead of us
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The Equity markets are failing to price in what is ahead of us. What has been priced in is a cyclical recovery. But this was not a cyclical downturn, it is structural. There are significant global imbalances that will take a number of years to resolve.
One of the biggest issues is the need for a significant amount of de-leveraging. The banking industry and the consumer have been de-leveraging to some extent, but the government have been borrowing record amounts, so overall debt per capital hasn't really started to come down yet.
The main risks to the UK economy in the next few years are:
• Significant cuts in government spending.
• Rises in interest rates
• Rises in taxation
• Increasing inflation from a weak Pound and very loose monetary policy
• Increasing inflation from rises in commodity prices
• Consumer saving rates increasing
• Increasing global protectionism
• Increasing regulation on the banking industry
From here the risk to Equities in my opinion is very much to the downside. But that is not to say that Equities won't rise further in the near term, as there is a real disconnection with reality at present.
Significant amount of propaganda has made us believe that there is no cost to the bank rescues and all the money that the government has had to borrow. There is also the assumption that there is no cost to all those pounds we have printed.
We have been told that interest rates an unlikely to rise for a long time and when they do go up, it will be gentle and they won't peak very high.
The low interest rates and low bond yields are also contributing to an asset bubble in Equities and Property. We are now in a speculative environment where significant volatility will persist for a number of years to come.