For the investor, it does not get much tougher than this. Markets have been awful. Almost any news is interpreted as bad, and it is even regurgitated to reinforce the effects it created in the first place.
For example, on 6 March 2009, HSBC's share price declined on the news that Michael Geoghegan, its CEO, had said that it was closing down Household, its North American business.
But exactly the same news had been included in HSBC's 2008 profits announcement on 2 March 2009. The news isn't even that bad.
Everybody knew that Household had turned into a disaster and it was somewhat refreshing that the senior management of a large UK bank was prepared to own up to a problem in one of its businesses and write-off the value in its results.
HSBC actually made over $5 billion in profits and this is after the write-off and increasing its provisions for bad-debt. And gross and net operating revenues rose by 1% and 3% respectively.
But since the week after announcing its results, none of this prevented a 30% decline in the HSBC share price. I have always said that fundamentals drive the long-term values of investments, but sentiment drives the short-term changes. Right now, sentiment is awful and markets are fearful.
So what of the fundamentals? Actually, these are excellent and equities offer better potential than they have for decades. In the UK, the dividend yield from the FTSE 100 index is just under 6%, which compares with a yield to maturity of less than 3% per annum on 10 year gilts. This positive dividend yield gap (ie. equities paying more income than gilts) has not occurred since 1957.
PERs (price earnings ratios) are now at around 7.2, which is another way of saying that when you buy UK shares, you are paying £7.20 for every £1 of profit generated.
Financial institution cash balances are now at record levels. Further, equity holdings are at record lows. The rate of return on cash balances has been unattractive for some time, but with interest rates cut from 1% to 0.5% (a 50% decline!) those yields have worsened. This is making it extraordinarily unattractive for financial institutions to hold cash, and gilts are not much more attractive when they are returning less than 3% per annum for 10 years (and everyone is mindful that inflation may destroy this value at some time in the not too distant future).
This is a very difficult market, but there is a lot of potential. Timing a recovery will be virtually impossible (as it always is) so we are sticking to our fundamental analysis and ensuring that we are well placed to benefit from a rise in share prices.
I believe, however, that when that happens it will be fast and furious as the sentiment will change, as it always does, from fear to greed. Sooner or later people will begin to realise that holding money on deposit with HSBC at less than 1% is likely to be significantly less attractive than buying HSBC stock with a dividend yield of over 10%. Until that time comes we will keep our equity exposure in place but remain diversified.
It will get better!
Gary Reynolds is director and chief investment officer at CourtiersIFAonline
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