By Alistair Byrne, director of insured business at Aegon Asset Management Global equity markets ha...
Global equity markets have recovered sharply from the lows seen immediately after the terrorist attacks on New York and Washington.
In part, this reflects investors' positive response to the interest rate cuts and other policy actions put in place by governments around the world to support economic growth. There also seems to be some relief that the US military response has been quite narrowly focused and supported by a broad coalition of nations.
Consumer confidence in the US was fragile even before the terrorist acts and there were signs that mounting job losses were beginning to weigh on the mood. Confidence has obviously taken a further major blow and public fears about safety are now combining with doubts about the economic outlook. Tentative signs that the industrial sector was bottoming have given way to expectations of a renewed downturn. Several industries, including airlines and leisure companies, face a dramatic deterioration in their business prospects. Profits will remain under pressure and it seems safe to conclude that further cuts in investment spending and employment are inevitable in the short term.
However, it is important not to neglect the ability of US policymakers to turn the direction of the economy. Short-term interest rates have been cut to their lowest levels since 1962 and the US government has backed this with substantial tax cuts and other stimulus measures. Unless there is a serious escalation in the war against terrorism, it seems likely that growth will begin to accelerate once more in the second half of next year. Confidence should begin to improve and normal spending patterns should be resumed.
Against this background, our valuation models continue to indicate that equities are trading at low valuations relative to bonds. This seems a fair reflection of the current risks and uncertainties, but our past experience is that this heightened risk aversion will abate with time. This suggests a high probability that global equities outperform government bonds next year. Bonds look stretched at current yield levels and are unlikely to perform well as increased government spending expands their supply.
In the circumstances, the sensible strategy is to retain a neutral stance on equities within a balanced portfolio. In the coming months, investors will have to digest a lot of bad news on the state of the economy and the weakness of corporate profits. This is likely to lead to a volatile market, but one that makes little overall progress. The key determinant of returns is likely to be stock selection and at the moment there is little to suggest that any one region is going to outperform significantly.
I would expect the next key shift of strategy to be to a more positive stance on equities. In the meantime, however, the current market volatility may well produce opportunities to invest in 'cyclical' or economy-sensitive stocks at depressed levels. While the short-term outlook for these stocks may be tough, managed funds should look to establish positions in cyclical sectors ahead of the recovery that is expected during 2002. Exposure to defensive sectors, which have performed strongly in recent months, should be unwound as the recovery comes closer.
Equity markets on low relative valuations.
Massive monetary and fiscal stimulus.
Depressed investor sentiment.
Terrorist situation has created uncertainty.
Consumer confidence remains fragile.
Corporate profits likely to remain weak.
Staying invested could prove lucrative
Consider lasting powers of attorney
Less environment, more governance threatens to undermine firms' green credentials
Evidence your compliance