History, timing and sentiment all say it's right to dive back into stocks
Another bear market rally or something more substantial? A year and a half into this equity bear market, investors, traders and advisers appear to have become conditioned to sell the rallies. Indeed, a number of high-profile individuals, investment banks and strategists have come out this week advising clients to sell this rally.
In the short term we'd agree. Nimble traders should take advantage of an equity market that is heavily overbought and due to give back some of its gains. Markets don't move in straight lines but ebb and flow and, after such a strong rally, some giveback is to be expected. Indeed, consistent with that, our risk appetite indicators, which have given timely sell signals throughout this bear market, are again back on sell (see chart).
Beyond the next few weeks, though, there is a growing case for expecting equity markets to perform well in both 2009 and perhaps into 2010. Technical, fundamental and valuation factors all conspire to suggest that this equity rally could have considerably further to go.
As a result of such falls in stock markets, equities are now attractive on most valuation measures. In particular, of the four main asset classes (equities, government bonds, cash and property) equities are the most attractive. Cash is yielding an effective zero return and is vulnerable to inflation eroding its purchasing power. Government bonds, especially since the introduction of quantitative easing, are close to multi-decade, low yield levels of around 3 to 3.5 per cent (UK 10-year bonds). Residential property remains expensive relative to average earnings while commercial property is offering an attractive yield, around 7 – 8 per cent. But current equity earnings yields of between 11 and 12 per cent (based on already dramatically reduced future earnings expectations) are therefore attractive when measured against other major asset classes.
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