Two-way opportunities in a "momentum market"

Are the May highs something of a peak? Global indices have kept edging up with an overall bullish consensus, helped here by the surprise election of a majority Conservative government. But mind, global recovery is in its sixth year and while valuations are hardly bubble-like, there are growing examples of stretched values which leave no room for upsets. Fresh money continues to resort to equities in a desperate search for return, but there is a sensitive balance with shareholders sitting on substantial gains since 2009 and 2012 especially, who will be conscious to protect them.

"All news is good news", at least for now

The US market's psychology remains upbeat. On days of bullish economic data, stocks rise in expectation of better corporate earnings; yet weak economic data is also inclined to boost stocks in the belief the Fed will delay raising interest rates - and even when this happens, it will be a very slow/modest process to limit dollar strength crimping US firms' profits. There are occasional down-days when the reality of eventual rate-rises strikes home, but the consensus weighs to interpret events optimistically - in an opposite way to how "all news is bad news" prevailed in 2009 and late 2011. Those experiences underlined how economic life shows "mean reversion" hence it is wise to bear in mind the consensus is sometimes flawed.

The forward price/earnings (P/E) multiple on the S&P 500 index is 17.5 versus a long-term average of 14.8. Such a rating can be rationalised if the US/global economy is poised for longer-term expansion, which is not impossible depending how trends in China/Japan and the US dollar play out, but there is a fair chance the current cycle is mature. To deny this implies the 2009 to 2012 period should be overlooked as exceptional, resulting from a very serious recession, and a fair benchmark is more like mid-2012. It only shows how macro-economics can get rather speculative. Most likely the high ratings of US stocks also follow from the weight of money chasing returns in a very low interest environment; but no scenario lasts so very long.

Greece is headlines again: time to worry or yawn?

The consensus still reckons on fudge at the eleventh hour, despite the Greeks and EU creditors being dug into their respective agendas. The sense is for a "managed default" regarding a series of payments due June/July to the International Monetary Fund and European Central Bank, which would keep Greece in the eurozone. Yet it increasingly grates how other southern European nations - taking the prescribed austerity medicines - are contributing to bail out Greece, while it lags on required reforms.

And despite risks with the "firewalls" until they are tested if Greece does leave the euro, there could be a greater risk if it continues to struggle under a circa €335 billion (£240 billion) debt stranglehold. Greece simply cannot generate enough demand in its economy, to genuinely move forward. The alternative of operating with a devalued drachma after debt write-offs, would make Greece much more competitive. So an irony with the US applying pressure to keep Greece in the eurozone, lest it comes under Russian influence, is this happening already unless Greece's political economy achieves better health. So, yes, there are reasons for vigilance, whichever outcome. Staying in the euro means the pressures continue to build; leaving it guarantees a short-term rumpus.

In terms of "jitter-worthy" news, the main risk would appear to be in July after a one-month grace period, should Greece soon fail to pay (as looks likely) a total €1.6 billion to the International Monetary Fund over 5 to 19 June. There is an initial potential default on €300 million due 5 June, the IMF being a senior creditor to the European Central Bank, due €3.5 billion on 20 July. Perhaps a key sign will be whether Greece starts printing separate IOU's as a means to cope, i.e. starting down a route to leave the single currency.

UK must confront deficits' reality; stocks increasingly high

In an effort to grapple with deficits early in the government's term, George Osborne has requested £13 billion departmental spending cuts and £12 billion welfare cuts. Many of the palatable cuts have already been made, so there is a risk to consumer spending from public sector job losses; significant cuts being needed to meet the Conservatives' election pledges of billions of pounds of tax cuts and healthcare spending.

Tax cuts would mitigate the effect of spending cuts on aggregate demand, but the Conservatives have not detailed how all this is to be achieved; we can only see how the 8 July budget maps things out. A risk with the economic recovery is it having benefited from "can-kicking" in recent years as the coalition government raised debt rather than cut spending. It remains to be seen if a stiffer Conservative "austerity" approach can be absorbed by the economy or what extent it may succumb.

So for the time being there is no real sign of profit warnings indicating change in the business cycle. It is very hard however to identify stocks with a genuine margin of safety, and more are extending their market values from fundamentals - e.g. Hargreaves Lansdown, Homeserve, Savills and Young & Co.

The common factor is "buying the story" with less regard to value credentials: a tactic that could prove right if the economy continues to improve, but leaves no room to miss hopes. It's now a classic "momentum market" in contrast to 2009 and late 2011 when stocks were available on cheap P/E's, fat yields, close to or below net tangible asset values. The chief risk to this go-go sentiment looks to be an austerity-zealous Conservative government, but US interest rates and Greece are also capable of cooling the party.

Governments and central banks have spent tools

Should the proverbial "black swan" appear also, a dilemma with already low interest rates and governments running big debts, is little scope for effective monetary stimulus. The hope is that accumulated stimulus in the US and monetary easing underway in continental Europe will manifest in better company earnings later this year. We can but see what evolves.

Altogether the different factors imply a sideways-volatile market is likely this summer than in recent months. Nimble traders can relish the prospect of getting their shorts on, and conservative investors need care not to be over-exposed.