In 1901, Charles Dow was quoted in The Wall Street Journal as saying: "The market is not like a ball...
In 1901, Charles Dow was quoted in The Wall Street Journal as saying: "The market is not like a balloon plunging hither and thither in the wind. As a whole, it represents a serious, well considered effort on the part of far-sighted and well informed men to adjust prices to such values as exist or which are expected to exist in the not too remote future. The thought with great operators is not whether a price can be advanced, but whether the value of the property which they propose to buy will lead investors and speculators six months hence to take stock at figures from ten to twenty points above present prices."
The fall in equity markets in recent weeks is understandable because of investors' increased concerns over the outlook for corporate profitability, particularly in the US. However, the UK equity market has at times felt more like the balloon in the wind over the last 12 to 18 months than Charles Dow's well considered effort.
As equity markets are, by and large, positively correlated, one must consider the outlook for the US, Continental European and Japanese economies before coming to a conclusion on the likely direction of the UK equity market over the next six to 12 months.
The Federal Reserve has cut US interest rates three times in quick succession over the past few months.
The Bank of Japan has also returned to its zero interest rate policy, which is positive. This may well prove to be the first sign that, at last, sufficient steps will be taken to re-inflate the Japanese economy by the authorities there.
Finally, the Bank of England also has room to cut interest rates further and embarrassingly, may well have to write a letter to the Chancellor in the next few months explaining why inflation has undershot the Government's target. Further cuts in interest rates should be sufficient therefore, to ensure that UK corporate earnings growth remains positive.
Furthermore, the bond earnings yield ratio for the UK equity market, at the time of writing, has fallen to a similar level as that of October 1998. Although it is arguable this ratio should be lower in a low inflationary economy to reflect the pressure on corporate margins and reduced pricing power, the balance of probabilities suggests the UK equity market will be substantially higher in twelve months time.
The recent fall in equity prices does offer some interesting opportunities. In a complete reversal of the technology, media and telecom bubble 12 months ago, some smaller companies' share prices have collapsed to levels substantially below those attained last year.
In most cases, shares in UK smaller company investment trusts can be bought at meaningful discounts to net asset value with the prospect of discount contraction and the potential for corporate activity in the sector.
Nick Brind is manager of the Exeter Capital Growth Fund
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