Testing conviction in a crisis of confidence
Mike Lenhoff – Chief Strategist
Brewin Dolphin
Investment Research
9 August 2011
Value and fundamentals may not count for much in a crisis of confidence but, for investors with a strategic focus, that is when they matter most. The difficulty is establishing what they are and, in the meantime, momentum is likely to be the more persuasive feature. But that can change!
Yesterday’s action had the feel of a climax sell-off and so does this morning’s. At the time of writing the FTSE 100 had retraced half of what it gained between the financial crisis low of March 2009 and this year’s peak (that level being around 4800). Chartists may regard such retracement patterns as critical re-entry points but like everyone else they will want to see how the market responds before committing themselves.
Given the extreme oversold condition of equity markets, a rebound is due even if it provides little more than momentary relief from the panic selling. But rather than focus on the technicals, it might serve more purpose to look at valuations in the light of the correction which has seen major indices such as the DJ Euro Stoxx Index, the S&P 500 and the FTSE 100 give up within the past two weeks some 18, 16 and 15 percent respectively as of yesterday’s close.
The chart shows the 12-month forward PE ratio for the FTSE World Index along with the bond-equity earnings yield ratio. While the odds of a US recession may have risen, the likely outcome is still modest growth but, even allowing for earnings downgrades, the prospective PE ratios are back to where they were ahead of the recovery in equity markets in the spring of 2009. The bond-equity earnings yield ratio is back to its low point during the financial crisis.
These metrics can be no more than indicative. Still, they illustrate in some sense the dichotomy that has arisen for the developed economies between a floundering in political leadership to confront the issues and the corporate world in which earnings are growing strongly. It’s all down to conviction. If you believe in the earnings story, as we do, equity markets offer value!
IMPORTANT NOTES
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