Bob Homan: Right for the wrong reasons

Bob Homan: Right for the wrong reasons

Bob Homan (Cor Salverius Fotografie) 980x600

By Bob Homan, Head of the ING Investment Office

We are experiencing an excellent year on the stock market so far: the world share index has already risen by about 14% since 1 January. That is much better than most market researchers had expected.

In many cases, the expectation of a recession was a reason to be somewhat cautious with forecasts. The minority that was somewhat more positive generally based this on falling capital market interest rates. In fact, both groups were wrong. A recession has not yet come about, the economy remains – contrary to expectations – reasonably well, but interest rates have not fallen either. On average, 10-year interest rates are even slightly higher than at the beginning of the year.

Yet that minority was right about its positive view of the markets. 'Right for the wrong reasons': reality is completely opposite to the general expectation. It was not interest rates that drove up prices, but the better-than-expected economy.

Again, the economic situation was not such that corporate profits increased sharply. The market has really become more expensive this year, looking at various valuation measures. In fact, compared to the risk-free rate, the market has not been this expensive in the past 15 years. Now that is fine, if in the future interest rates fall and profits rise again. There is also a negative correlation between the two in the short term: if economic growth improves, interest rates will probably also rise, and vice versa.

However, neither of these two factors should move too fast, because that hurts the other. We saw this in the first weeks of August, when the better-than-expected growth, and as a result rising interest rates, started to hurt the market. In that respect, the recent disappointing economic figures were welcome.

Meanwhile, expectations have turned. The negative market researchers no longer count on a recession, while the general idea is that interest rates are now really close to their peak, or have already passed it. Interest rates and the economy must balance each other very well, but who knows. And otherwise you can still be right, for the wrong reasons.