Published in Le Jeudi (Luxembourg) on 3 April 2013
 

Last week, the S&P 500 at last hit a new all-time high. “At last” because it had already brushed up against this level on several occasions recently and had been expected to break through for some time already. The previous high goes back five and a half years, to October 2007. In and of itself, this new record is mostly symbolic. It is not like a sports medal or a victory in another discipline that sends the winner into the pantheon of heroes. In the world of finance, a market record is merely one step on a volatile and, in theory, limitless (as long as our companies create value) ascension in the index. Moreover, it places us before two frustrating questions: have I gotten in enough on the market rally? And what factors will send the index to its next summit? The answer to the first question is that many investors are very likely to have missed out on the rally, or not to have taken part in it sufficiently, perhaps because they sold at the darkest hour after the Lehman crisis in autumn 2008 and never had the fortitude to return to the market. With 20-20 hindsight, it is always easy to say what you should have done. Nevertheless, some lessons can be drawn from the period between October 2007 (the previous high) and now. The first of these is that the investor’s investment horizon must serve as his compass for any investment strategy. This makes it possible to see beyond market volatility, which can be extreme during crisis periods. The second of these is the phenomenon of reversion to the mean, i.e., good performances come after bad ones (and vice versa).  To sum up, if performances were poor, you can count on them getting better (as long as you are patient). Conversely, spectacular returns are likely to be followed by far more moderate ones. The third lesson is that valuation matters. An asset that has become very cheap because its price decline overstates a worsening in fundamentals will ultimately move back up, unless new sources of concern emerge (this is why European indices have remained far behind US indices, as the economic upturn ran into the euro zone crisis). The fourth lesson is that the central bank plays a decisive role in equity market behavior through its conventional monetary policy (i.e., cuts in official rates) and/or non-conventional policy (quantitative easing). Ultimately, the gap between Europe and the US reminds us of the importance of international diversification.

All these points involve the past but also the future, when a new crisis will break out (let’s not overlook the fact that crises are recurring phenomena). For the moment, investors should focus on the second question: what factors will allow the index to reach its next summit? On the one hand, the combination of highly flexible monetary policy and an improving economy should in theory enhance investor risk appetite. On the other hand, the prospect of new tense discussions in Washington D.C. by mid-May to draw up a multi-annual strategy to reduce the public deficit that would make it possible to raise the debt ceiling could curb the enthusiasm of return-seeking investors. Meanwhile, in the second half commentary will be dominated by the end of QE3 (i.e., the Federal Reserve’s halt in its purchases of government paper and mortgage-backed securities) or on the timing of the first tightening in monetary policy. In conclusion, the easy money has already been made, driven by highly aggressive monetary policy reflecting Ben Bernanke’s fears that unemployment was not receding fast enough. Economic growth and earnings will take over as the dominant factors and investors will want enough growth but not too much, so that the Fed does not tighten too fast.

William De Vijlder
Chief Investment Officer, Strategy and Partners, BNP Paribas Investment Partners