Equities now look attractive versus bonds and should outperform in 2002, despite the continued lack ...
Equities now look attractive versus bonds and should outperform in 2002, despite the continued lack of visibility surrounding corporate earnings.
The recovery in global equity markets since the trough of 21 September has been cyclical-led and not without volatility, but for the first time in over a year, the bulls are beginning to point to equities as the most likely top-performing asset class of 2002.
Stephen Potter, analyst at Goldman Sachs, says although equities are still trading at levels pricing in potentially unsustainable earnings growth, they are now at reasonable value compared with bonds.
He says: 'Although equities are still high in an absolute sense when judged against historical levels, most equity-bond valuation models show equities to be neutral to inexpensive versus bonds.'
Potter says it is not unusual for markets to recover when output and corporate earnings are still being revised down.
He adds that the 18% recovery made by global equities to the end of November since their September lows mirrors moves seen in earlier post-crash markets. In the first six months of the 1990-1991 recovery, equities posted growth of 20%, for example.
Indeed, the last two major market recoveries proceeded consensus forecasts that global economic growth would continue to come down. Potter says: 'In the 1990 and 1998 market rebounds, equities troughed six months and four months, before consensus earnings momentum bottomed.'
It still remains unclear how much of the recent rebound was an adjustment to the overreaction that followed 11 September, according to Mike Lenhoff, chief portfolio strategist at Gerrard. While he believes that the positive newsflow from Afghanistan has buoyed investor sentiment, he stresses the prospect of a US led recovery remains the key driver behind the market.
Quick recoveries also bring about their own dangers though, Lenhoff adds.
He says: 'The equity market is now overbought, so there will be some profit-taking. The issue is whether the profit-taking will push the market all the way down again or whether it will merely lead to a brief period of consolidation.
'If the latter, this will allow the market to catch its breath in preparation for an assault on what is a key area of resistance of the FTSE 100, namely that between 5,400 to 5,600.'
While equities have typically had strong runs in the aftermath of slowdowns, corporate bonds have also typically outperformed, notes Bob Yerbury, chief investment officer at Invesco Perpetual.
Yerbury says: 'In the US, the high yield corporate bond market outperformed the S&P 500 index in each of the years 1991, 1992 and 1993, that is, in the period of economic recovery after the last US recession.'
Yerbury believes the UK will avoid recession next year, but says the corporate bond market has priced in a recession, providing attractive opportunities.
He says: 'If that view proves wrong, as we think it will, the yield differential between corporate and government bonds should narrow as economic growth recovers, providing some capital appreciation potential from corporates, relative to gilts.'
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