SELL IN May and go away is an old stock market adage that suggests investors should sell equities in May and return to the market in the autumn. This year investors – not least those in the Irish stock market – would have been wise to ignore that financial advice. Recent market trading has seen an impressive rally in global stock prices.
That rally now raises the question of whether the sharp recovery in equity markets can be sustained. Stock prices have been boosted by an improvement in company earnings. But in many cases companies have achieved that improvement by aggressively cutting costs to produce some impressive but one-off financial gains. And figures last week showed economic activity in the world’s largest economy had declined again, with the US recording its fourth consecutive quarter of negative growth.
A buoyant US stock market has plainly disregarded the reality of a depressed domestic economy that is still struggling to escape from recession and from a collapse in consumer confidence. Against such a bleak background, rising equity prices set against the backdrop of a contracting economy may seem somewhat counter-intuitive. Stock markets, however, are discounting mechanisms. A company’s share price reflects its future financial prospects, rather than its current financial position.
The Irish economy is expected to contract by 8 per cent this year, one of the sharpest rates of decline in the industrialised world. Nevertheless, the Iseq, an index of Irish shares, has risen by one-fifth so far this year. And yet, despite that impressive performance, it is still two-thirds below its all-time high reached in 2007. In Japan, equities have also performed strongly this year. But there, stock prices remain 75 per cent below their market peak in 1989.
For investors in Irish equities, the scale of the stockmarket reversal since 2007 has been both unprecedented and traumatic. Because the Irish market was dominated by financial and property companies, it was hit hardest by the global economic downturn – greatly accentuated by the domestic property bubble. The State’s two main banks, Allied Irish Banks and Bank of Ireland, which in 2007 accounted for one-third of the Iseq index now represent less than 10 per cent and face an uncertain future. Their fate, whether in private or State ownership, may well be decided by the National Asset Management Agency (Nama) and by the terms set for taking over their bad property loans.
Rising stock markets, it is sometimes said, must scale a wall of worry. Equities are risk investments traded in conditions of day-to-day uncertainty. Current global uncertainties concern the US economy: when it will move out of recession and how quickly. And whether China, faced with a collapse in world demand for its exports, can stimulate its economy without creating a destabilising financial bubble. How the US and China manage to handle their respective challenges in the months ahead will greatly influence the direction of world stock markets.