29th May 2012
When markets are tumbling, there is always one cheery soul who suggests that they might be on the verge of capitulation and are therefore about to turn. This time Larry Fink, chief executive of BlackRock, has put his head above the parapet, buying back $1bn of the group's own stock on the premise that equities are cheap relative to bonds .
Yet, John Authers makes a convincing case in the Financial Times for why the markets may not yet have hit the bottom in his piece 'Cult of equities is dead. Long live equities.'
"(If you) talk to fund managers, it is obvious that they are buying bonds not because they are in the grip of a cult or bubble mentality, but because regulations force them to do so. This is financial repression – to deal with the debt they took on to quell the credit crisis, governments are forcing us all to lend to them at ruinously low rates. While artificial incentives to buy bonds stay in force, bonds could stay expensive – and equities could stay relatively cheap.
In absolute terms, stocks do not look so cheap, and the backdrop is not as propitious for them as it was in 1954."
He points to comments by Rob Buckland, Citigroup's chief global equity strategist, who believes that the equity cult is "still dying". At the start of previous equity bull markets, "baby boomers were at school, not retiring, there was no inflation-protected bonds market to hedge against inflation (equities had to do that job), and equities were not heavily correlated with other assets, as they are now."
In previous bull markets the influence of pension funds was crucial and the latest data from pension group Mercer suggests that they are not showing any passion for equities: "Pension fund allocations to alternatives increase as European investors, rattled by the volatility created by the Eurozone crisis, continue to turn their back on the equity markets, according to Mercer's annual European Asset Allocation Survey…
"Mercer's research reveals that schemes in traditionally equity-heavy markets such as the UK and Ireland still have the largest equity weightings although they have witnessed the largest falls in equity allocations, mainly driven by a move away from domestic equities. In the UK, average allocations to domestic and non domestic equities fell by 4% (from 47% to 43%) over the last 12 months. In Ireland the current average allocation to equities is 44%, down 6% from last year and down over 20% since 2008."
In the meantime retail investors continue to pull money out of the sector with small dramas such as the Facebook flotation denting sentiment towards equities : "Not like this will come as a surprise to anyone in the aftermath of last week's abysmal FaceBook IPO which pretty much killed all retail interest in equity markets, but in the last week, the "dumb" money pulled another $3.5 billion out of domestic stocks per ICI, bringing the total tally to 13 consecutive weeks of outflows, and 52 weeks of outflows in the past 56 weeks, with redemptions amounting to $46 billion in 2012, compared to just $6.5 billion for the same period in 2011."
However, Authers article has drawn out some with an opposing views: Mehmet Gerz, for example, says:" Pension fund accounting may be playing an important part in the ongoing bond bubble and repression of equities. But, the rules of mean-reversion, no matter how long they may take to reassert themselves, will work in favor of those true long term investors taking the side of the "perverse" pension fund trade." In other words, investors should not expect quick results, but now is as good a time as any to re-enter equity markets.
Others suggest it is executive pay that is holding back share prices. Pyatnitsky says: "Until the managers of companies reduce their rake-off the yields on equities will remain poor. Get back to 1950's relative remuneration levels and we'll get back to a 1950's equities boom." If this is the case, then the recent scrutiny of executive pay could be the key to reigniting the bull market.
There are undoubtedly some equity markets where sentiment is unlikely to get significantly worse. On Business Insider , the recent performance of the Greek market has shown that even dead cats can have their bounces.
There is still hope in equity markets, and by definition, while there is still hope, markets haven't hit the bottom. There is still downward pressure from pension funds and retail investors. When the papers start proclaiming the end of equities, then markets may have reached true capitulation.
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