Despite recent setbacks we continue to favour equities

EQUITY markets had a turbulent week last week as risk aversion moved sharply higher.

EQUITY markets had a turbulent week last week as risk aversion moved sharply higher. Investors are still choosing to focus on the potential fallout from Greece’s ongoing debt woes and, more recently, the lack of a clear majority for any of the major political parties following the UK general election.

Many stock markets are now in negative territory for 2010 to date, with the euro area perhaps unsurprisingly suffering the brunt of the falls.

As we have written about for some time, a setback in equities is not surprising given the strong rally they have enjoyed since March 2009. However, the extent of the sell-off in European stocks (one of the asset classes that we currently favour on a global basis) is surprising, and in our view looks to be overdone.

The four key pillars of support for global equity markets – the economy, earnings, valuations and liquidity – have not been altered fundamentally by the events in European sovereign debt markets.

The economic data continues to signal ongoing improvement, most notably in Asia and the US; recent corporate news flow shows that earnings are still rising; equity valuations still look attractive, and more so after the recent sell-off.

Furthermore, with global inflationary pressure subdued overall, interest rates still remain anchored at emergency levels in many economies. This means that liquidity is high – something that is often a key condition for progress in equity markets.

Investing in equities always involves an element of taking risk, and this is never more apparent than at times like these. However, as investors, what we must ask ourselves is whether the profits, cash flows and valuation discounts currently on offer provide a fair reward for the risks we have to take. Sometimes of course they don’t, but at the moment we think they do.

That is why we reiterate our view that the current sell-off in markets – though very unnerving at times – shouldn’t be a cause for major alarm. Instead, it should be seen as part of the natural volatility that is likely to be seen in any longer-term market recovery.

Interestingly, despite the sharp rise in volatility in recent trading sessions, the best performing area of the market over the last month has been the economically-sensitive consumer discretionary sector, while the worst has been materials (where we remain underweight).

Two sectors where we currently have a positive view – industrials and information technology – also outperformed, but only because they fell by less than the wider market.

Although recent events will have undoubtedly unsettled many investors, we see no reason to change our fundamental preference for equities over bonds and cash, or indeed the sector recommendations that we make within equity markets.

We still firmly believe that capital expenditure by corporations is likely to pick up, which should support the information technology and industrial sectors and we choose to fund these positions from the fairly expensive cyclical recovery sectors, namely materials and consumer discretionary.

Undoubtedly these are worrying times for economic policymakers in Europe and elsewhere, but the main supports for equity markets remain in place.

Andrew Miller is regional office head at Barclays Wealth in Newcastle

 

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