Edmond Jackson's Stockwatch: The Big Picture

Factors I discussed in my last macro piece have boosted markets during August. Second quarter US company reporting continued robust and UK firms say they are trading broadly in line with expectations. The Middle East conflicts have not fuelled a rise in oil prices which trade at a 13-month low; and Ukraine is largely a civil war, the country outside NATO which therefore will not intervene.

Price/earnings multiples are not stretched and dividend yields of 3-5% are available, respectably covered by earnings and cash flow. So for as long as central bankers can be trusted that interest rate rises will be small when they eventually happen, a strategy of "buy the dips" applies. How secure is this though?

US company earnings have lent a prop

A principal fear for 2014 was US earnings liable to wilt along with the central bank's monetary stimulus; and some economists warning that profit margins were also poised to turn down. Results to date have discredited this scenario although the true test may be spring 2015 onwards: allowing time for October's conclusion of quantitative easing, to show up in results.

Yet on a wider view investors may still enjoy net monetary stimulus: the European Central Bank has indicated it is willing to add €1.1 trillion (£873.9 billion) over the next two years, a circa 50% expansion of its balance sheet; and China has printed Renminbi at the counter-value of $50 billion a month this year.

US employment trends are vital in this respect. Janet Yellen, chair of the Fed, has said it will likely keep interest rates very low after October, assuming inflation expectations remain low also; "but if progress in the labour market continues to be more rapid than anticipated...or if inflation moves up more rapidly than anticipated...then increases in the federal funds rate target could come sooner...and could be more rapid thereafter."

So a key and ironic risk would be the US continuing to surprise on the upside, with its labour market tightening. The problem is less about the effect of increases in rates on the US economy itself than on so many complex cross-trades nowadays in international finance, especially with developing countries. A rising dollar could wreak instability on a much bigger scale than we saw in early 2014.

Mind how some stocks are jumpy

This is a typical sign of a bull market possibly maturing. For example in the US, Burger King Worldwide leapt an initial 15% simply after declaring talks to buy Canadian coffee-and-doughnut chain Tim Hortons, itself up 20% on the news. The deal is mainly driven by financial engineering than genuine fundamentals, moving Burger King's tax base to Canada to create a tax advantage. Here, ASOS similarly jumped 15% in response to press speculation it could become a bid target.

Whether such a mood continues is guesswork in social psychology: the sight of shares being suddenly re-rated could attract more people; but bear in mind also, substantial flows of money into investment funds already show public eagerness for stocks - something that contrarians will recognise as the seeds of a bear market similarly as a bull market emerges amid pessimism.

China remains a major risk lurking

Bears have growled on China for two years or more, apparently discredited as the economy has retained strength. Yet the facts remain, China's business cycle has been gargantuan and weighted to infrastructure, e.g. as much cement used in 2011/12 as did the US in the entire 20th century, and credit expansion over the last six years equivalent to total loans of the US banking system.

Western media appears to have lost interest to report how latest economic statistics are down - the purchasing managers' index, foreign direct investment, new house prices, imports - thereby putting more pressure on the authorities to stimulate economic activity. Can China's autocrats manage though?

The key risk is if the Chinese currency devalues hence slashes prices of its traded goods, to hurt international firms' revenues and profits. If this were to coincide with US interest rate rises then it would be a rude awakening to recent equity investors and those who have become used to five years of overall rising prices - i.e. a serious jolt to fundamentals and sentiment.

UK company updates affirm the status quo, yet charts present a dilemma

Interpreting company news I find trading updates generally "in line with expectations" with no real change towards positive or negative surprises. What is curious and relevant to equities' risk is how charts show strong rises in the second half of 2013 (despite no significant improvement in news) then spent 2014 consolidating or falling (again with no significant change in the tenor of news).

This could be interpreted as investors' anticipating economic recovery then possibly a "blow-off" representing the final exuberance of loose monetary policy. Bulls can take heart, this consolidation has happened well before market values became extreme. Mind the bearish scenario also, how it could represent flagging enthusiasm with gains to protect - especially if the macro situation turns adverse.

WPP is exemplary: as the world's largest advertising and marketing services group, it is a "quality cyclical" FTSE 100 share with just the kind of chart that intrigues me. 2013 saw a 53% rally to 1,383p; this year a declining trend to 1,175p, now re-testing 1,250p. On 26 August it reported interims where media coverage tended to cite only a 1.5% rise in interim pre-tax profit to £532 million; however in constant currency terms WPP's progress was much stronger, up 15.5%.

Similarly reported revenues rose 2.7% to £5.469 billion, albeit up 11.3% in constant currency. WPP derived only 13% of revenue/profit from the UK last year, so stronger sterling masks its momentum. All this is significant to judging the global business cycle because WPP reflects companies' confidence to promote their products and services - in response to demand - which could all have a self-reinforcing effect in years ahead.

"Following the group's record year in 2013, 2014 has started stronger... Despite various geo-political concerns... current nominal worldwide GDP forecasts for 2015 indicate a similar growth rate at around 5.4%. This suggests that 2015 should be another good year for our industry..." WPP shares trade on possibly 13-14 times projected earnings, which is fair enough and not overblown. It implies a major jolt would be needed to de-rail the global economy.

Markets are yet to appreciate UK political risks

There's a lot to swallow over the next year or so - the Scottish referendum, next year's UK general election and possibly a referendum on European Union membership - which could combine to check business confidence. The realities of a Labour majority government are not being considered, but could come into focus with the party conference season and as MP's gear up for the election. Boris Johnson may attract disillusioned Conservatives from voting UKIP, however this split vote remains the enabler of a Labour majority - especially if Labour can appeal successfully to those excluded from property ownership and wage increases.

Obviously much will depend on campaigning skills. History suggests the stockmarket generally does better under Conservative-led governments than Labour (as shown by the last 5 years) so mind the propensity for change.

Flotations will help define the next stage of any bull market

New stories are essential to sustain a bull market, where the 2014 consolidation may also represent investor tiredness, weighing up the same stocks. Will this autumn's mooted flotations provide convincing new leaders for the next stage of a bull market, or more represent private equity owners unloading indebted firms? 2014 has so far seen a mixed trend with scepticism over the likes of Pets at Home although I have described how Card Factory could be the next discount retail winner.

Overall resilient for equities

So if interest rates remain low by historic standards, "buy the dips" looks likely to prevail than a change to a serious bear trend. But you need to watch the key risks I have outlined as the autumn season - traditionally difficult for markets - gets underway.