Equities look set to prove the naysayers wrong

13th September 2010

Markets are gently settling into their new term, and so far it's been good news for their worried parents. Having vacillated at around 5,000 to 5,200, the FTSE 100 has gained around 300 points since the start of September.

This was always likely to be a crucial time. The summer months tend to see thin trading volumes and the ‘back to school' period was always likely to be a statement of intent for the next quarter.

To what extent can equity investors be encouraged by this positive start?

It would be remiss not to point out that there are still a lot of naysayers about. Take SocGen's arch-bear Albert Edwards, who believes markets are simply failing to realise that they are in a ‘vulcan death grip'.

Those who support his view generally point to the weakness of economic data, which in turn points to an imminent double-dip recession.

Of course, there are also the ‘hell in a hand-cart' minority. Also on Alphaville, the FT quotes Nouriel Roubini and Ian Bremmer:  "Driven by ever-more- desperate policymakers in the US, Europe and Japan, these cycles will both shorten and magnify.

"Political, policy and regulatory uncertainty will increase, and as a result, financial crises will become more frequent and costly, while risk aversion, volatility and uncertainty will rise."

But these views tend to be given more than their fair share of air time. As HSBC Asset Management's Neil Jungbacke points out: "Equities look cheap. The UK market is on a p/e of around 12x, which is historically low."

These valuation considerations are likely to be more significant to the majority of investors who, after all, have to put their money somewhere.

Econoclast on the FT says: "Isn't Albert in danger of doing what he accuses others of? He's picking data that confirm his view of the world. Let's ignore the better-than-expected nationwide manufacturing ISM and payrolls and concentrate on the Philly Fed workweek."

This article in The Times makes a strong case for equities. In it, Simon Ward, an economist at Henderson, points out that when the money supply is growing faster than industrial output, equities tend to do well.

This is because the excess liquidity in the system has to find a home and tends towards the equities market. In contrast, when money supply is outpaced by industrial output equities have underperformed.

It continues: "The two measures flipped over in February of this year, with industrial output moving ahead again. Since then, as we have seen, equities have underperformed.

"Mr Ward expects a crossover again, in the opposite direction, when the figures are available for this summer, which should be good news for equities in the fourth quarter."

Equities also have the advantage that bonds are offering very little as this article, Investors on the verge of disaster, on the Motley Fool makes clear. There is little rationale for buying gilts at historically low yields, when low-risk blue chip equities are paying 5%-7%. At their best, the upside on gilts is unlikely to give investors more than inflation, at worst, it could provide a capital loss.

It seems likely that markets have gone back to school in a more serious-minded mode. This means no more messing around with expensive assets and trying to uncover real value.

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