Edmond Jackson's Stockwatch: The Big Picture

Risk looks to weigh on the downside with investors jolted by "surprises" they ignored while the stockmarket party roared on: the US Federal Reserve starting to wind back its exceptional stimulus; corporate profits peaking unless revenues improve; and strains in China amid colossal debt expansion.

Exuberance begat opportunism by way of a record level of margin trading in the US and some 25 flotations scheduled for the London market by Easter as venture capitalists cash in while they can.

The calibre of new firms floating is a significant factor defining the strength of a bull market - so if they are growth companies, in particular selling exciting new products abroad, then it inspires confidence for the UK economy.

Recently however we have been offered the likes of the Alton Towers theme park operator Merlin Entertainments - over 200% geared, on a high price/earnings (P/E) multiple - which wasn't what I look for.

Mind that as people expect stocks to rise they are driven by hope but when fear sets in they can panic and dump.

Institutional investors supposedly act more responsibly but are subject to peer performance tests and hedge funds are swift to manoeuvre on the short side - exacerbating falls. Pity the dilemma of private investor advisers urging "Don't panic, hold on!"

That's a worst case scenario but it's played out repeatedly over time, so be aware.

A key factor in stocks' risk/reward profile is the trend in financial reporting. I pointed out in my end-December macro piece, the media and market were overlooking a 9 December survey showing US companies issuing the most negative earnings guidance since 2001, which reflected over-optimism in the stockmarket but implied underlying risks too.

Managers have largely cut what costs they can and earnings per share have also been enhanced by deploying cash piles for buybacks; so revenue growth is now a lot more significant for equity valuation and this is precisely where some reports aren't looking good. If central banks' money printing has genuinely stimulated the real economy than over-inflated asset prices, those top-line figures must improve.

Dominant influence

The US stockmarket and monetary policy remain a dominant influence: after stocks rose nearly 30% last year in the latter part of the Fed's $85 billion (£51.5 billion) monthly stimulus, it meant the historic P/E multiples had expanded from 12.8 to 17.3 over two years.

To an extent this was justified by mean-reversion from levels when fears were spread even by chairman of Soros Fund Management, George Soros, of a collapse in the global economy.

George Soros could be right this year, defining China as the major global uncertainty.

Yet questions remain, what extent of stability has been bought by the Fed quadrupling its balance sheet to $4 trillion since late 2008? Monthly reductions of $10 billion (just lately to $65 billion) look likely to continue unless domestic events turn dire; the Fed was criticised last year for wavering on guidance, so needs to demonstrate genuine policy than one made on the hoof, otherwise it risks losing authority.

So capital flows that have benefited developing countries in recent years also look set to continue their current reversal, and interest rate rises (Turkey, India, South Africa) in defence may undermine economic and political structure.

Such trends are increasingly relevant to multinational firms: after a sales warning from Unilever last September it has just cited growth in emerging markets down from 11% to 8.7%, however it still expects to step up investment there, especially Africa, India and Indonesia.

Unilever's 57% of sales from emerging markets are targeted to rise to 75% by the end of the decade and its chief executive says: "The reality is that 80% of the world's population will live outside Europe and the US... growth here remains well above that in the developed world and will continue to do so." This is interesting as it implies a panic would be a buying opportunity.

The emerging markets' trend is also defined by China where weaker economic statistics coincide with colossal debt expansion - from 125% of GDP in 2008 to 215% in 2012 with credit spiralling from $9 trillion to $24 trillion.

Fitch credit ratings agency estimates that 12.5% of China's GDP now goes on interest payment and will rise to 22% by 2017. Can this be managed without a domestic and wider crisis?

One problem is that too much money has been sunk into investment projects to boost GDP than generate a real return; another that the debt issuers are not the primary beneficiaries of growth, instead the government via taxes while the local debt issuers tend to depend on land sales. So there is a big question whether China can grow out of its credit bubble unless the debt service capability of debtors improves.

Imagine the chaos if land/property prices fall. It is also hard to know what to trust in Chinese statistics from the top down: is a projected slowing from 7.5% GDP growth to 7.0%, credible?

"Eerie resemblances"

Credit has further expanded into high-risk/return instruments to support what may be bad debt. After George Soros predicted riots on American streets in 2012, his latest warning may need a pinch of salt but he cites "eerie resemblances" between the 2008 global financial crisis and China's debt market, as off-balance sheet debt has allegedly soared to $4.8 trillion.

The new year saw a liquidity crisis where the People's Bank of China injected $55 billion equivalent into the interbank lending market; such a gesture of loose monetary policy may be the only way of coping but hints at can-kicking.

The hope is that negative views from the West under-estimate scope for central control by the Chinese Communist Party. We shall see.

Meanwhile, global equity falls linked to weak Chinese manufacturing data are logical: the world's second largest economy has driven various commodity markets also machinery exports, and become the world's largest market for cars, oil and gold.

George Soros could be right this year, defining China as the major global uncertainty.