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Are we nearly there yet?

Another week, another post-crisis high for developed-market stocks. How much further, realistically, can they go? The MSCI World index, which captures large and mid cap representation across 24 Developed Markets countries, has now risen 21% in six months without even a 5% setback.

This seems unusual. Many pundits go further, arguing that there is a big “disconnect” between stock prices and the real world, and that they shouldn’t be rising at all. We will not be surprised when the setback does arrive – but we doubt it will mark the end of this investment journey.

Excesses

The last two surges in stock prices were followed by dramatic reversals. We think this one need not be. In 2000, stocks looked egregiously expensive: dotcom mania convinced many that scarcity had been abolished, and the rest of us just didn’t “get it”.

In 2007, stock valuations were unremarkable, but a toxic mix of expensive and complex credit instruments was poised to bring markets down. This time around there are fewer excesses needing correction.

Underpinning

It would be wrong to describe fixed income markets as being in a “bubble”. When dotcom stocks and toxic CDOs went bust, investors lost practically everything.

Now, however, the bulk of the nominal worth of today’s bond market is underpinned by credible par values. Meanwhile, the banking system is less stretched than in 2007. Stocks themselves look positively inexpensive now – and could remain so even when bond yields trend higher.

Stock prices should trend higher alongside corporate profits and dividends – otherwise their yield would rise indefinitely – and there is no practical ceiling for these.

They can grow as long as the global economy does, and despite worries about natural resources – or China’s pollution – no economist has yet been able to identify a limit to long-term growth (and lots have tried).

Effect of recession

Of course, recessions can hit the economy and profits: the damage they do is short-term, but it can be big. And the economic rebound from 2008’s trauma has been lacklustre.

But there is less of a disconnect between the economy and stocks of late than you might think: global GDP regained its real pre-crisis peak in late 2009, and has since been nudging steadily into new territory (as it usually does – and on a per capita basis too).

Despite all the worries about a “great deleveraging” and the “new normal”, core US private spending has grown in real terms by 3% for almost three years, and the labour market is improving steadily if slowly.

Europe continues to languish, for sure, but overall, global growth exceeds its stall speed. And in our view, the sharp decline in stock prices after 2007 more than made good the earlier excesses in credit markets: much of the rally to date has been a catching-up, not a leaping ahead.

Opportunity

Conclusion? The rise in stocks to date is still not especially surprising or outlandish, and we think the overdue short-term setback will likely prove an opportunity for long-term investors.

As always, we do emphasise that investing in shares is not for everyone. Their value can fall and you can get back less than you invest – if you are unsure, you should seek independent advice.

This was posted in Bdaily's Members' News section by Barclays Bank PLC .