These times are getting interesting
The FTSE 100 share index is now up 30% over five years, while earnings have fallen by 80%. On an earnings yield of 1.6%, the stock market could fall by 80% and, provided profits did not fall, would be on a 13x P/E multiple. The Bank of England is proud it has engineered such a pleasant result, but there is now increasing evidence that this is unsustainable.
On the back of the uncertainty for overseas investors in UK PLC following the Brexit result, the current account deficit is ballooning and the budget deficit is following. Carney, the Governor of the Bank of England, has responded by flooding money markets with more cash, QE and in the process, supporting the government 10-year bond at a current yield of 1.2%. However, as sterling falls against all its trading partners’ currencies, it is mechanically ensuring inflation rises up through 3.5%.
Traders have been buying into sterling weakness on the back of an 18% fall in the trade weighted index since the Brexit vote, but do they not understand that the further the pound falls, the greater the difference between next year’s inflation rise and today’s interest rates? Sterling is getting more expensive the further it falls. Carney is really under pressure and should be raising interest rates, but it now looks as though a rise in interest rates will be over his metaphorical dead body.
We are now destined to have a recession in the UK as well as inflation. It will be difficult for the stock market to remain above all of this. What QE has done is make investors complacent but also optimistic that only an upturn in economic activity, spelling higher profits, could trigger upward interest rates. What the UK is promising is rising wages, recession, inflation and falling profits. Not exactly the prize that ticket holders in the FTSE and the gilt market paid up for.
September 2016 report