RISK assets are still at or close to their post-crisis highs, and in many cases are well above the moving averages followed by technical analysts and traders. So some short-term correction would hardly come as a surprise, as we noted last week.
Potential triggers for such a correction were much in evidence last week. Sovereign debt fears have spread more visibly beyond Greece to other “peripheral” Eurozone economies, including, this time, Ireland. Tighter regulatory scrutiny of the banking sector has been highlighted, and intensified perhaps by the sector’s embarrassingly-rapid return to profitability.
Monetary tightening continues in emerging and commodity-producing economies, although the major developed world central banks seem likely to be waiting a while yet for the labour market recoveries that will prompt them into action.
So should long-term investors sell their “risky” assets? We still think that the answer to this question is a clear “no”. We doubt that a correction will be large or lengthy, not least because missing from the trigger list above is the likelihood of renewed economic weakness. As we suggested two weeks back, the macro debate has moved on.
Encouragingly, business sentiment is improving even in the Eurozone – partly, no doubt, because of the cheaper euro that is a by-product of Greece’s predicament, a development that we expect to be sustained for the foreseeable future. Many consensus growth forecasts are also firming up again, led by the US.
This is augmenting what was already a substantial projected rebound in corporate profits and is serving to highlight the marked difference between corporate and government credit worthiness.
On a six-to-nine month view, we stay positive on stocks and high-yield credit in particular. We would stay invested, and advise nervous investors to look at portfolio protection in the form of “put” options (ie the right to sell an investment at a given price, during a given period of time).
Such “put” options have, helpfully, been made cheaper by the decline in market volatility. For investors looking to diversify out of cash, we would advise using any short-term market setback as an opportunity to do just that.
In our view, equity valuations are not high. We think the US market, for example – still the bellwether – is trading on a plausible price/earnings (PE) ratio for 2010 of roughly 15, based on our forecasts. And as risk appetite slowly returns – visible again last week in the continuing outflow from US money market mutual funds, a large repository of the “safe haven” capital that has missed the rallies to date – we may find that institutional investors in particular revert to the valuation tools that they would use in more “normal” times, such as discounted cashflow (ie an analysis of likely future cashflows, allowing for the “time value” of money).
Such measures should make stocks look more attractive still.
It might seem unusual to be arguing that a market that has risen by 80% is still inexpensive, but remember that equities stocks – and corporate profits – fell a very long way first. Pessimists can lose their bearings too.
Andrew Miller is head of the Newcastle office of Barclays Wealth