Don't get mad

Andrew Pitts

Just about everyone is gloomy these days – unless you are lucky, or reckless, enough to have all your money in oil and other industrial commodities.

And with crude nudging $140 a barrel on 16 June, the economic woes seem to keep piling up.

Highly indebted consumers aren’t spending, their mortgages are crippling and their houses aren’t selling. Commercial property is doing even worse. Inflation is persistently high, which means interest rates will not fall anytime soon.

Global stock markets keep changing their tune. First, the indices say it’s going to get bad – really bad – then they perk up a bit, before turning all glum again. And so it goes on.

Investors could be forgiven for shouting: ‘I can’t take any more of these mood swings – get me out of this asylum!’ But that way lies madness: time will smooth out these violent short-term fluctuations.

Sceptics might scoff at me taking refuge in the long-term trend. They have a point – after all, the FTSE 100 index on 22 June 1998 was 5877, a level not dissimilar to today. But if there was ever a time to take money off the equities table, it was in late 1999, when the stock market really had bopped (until it dropped).

So what are the good drugs to reach for in this world of pain? Let’s run through them, with a little help from Guy Monson, chief investment officer at Sarasin and the architect of the Equisar range of thematically driven funds:

• I stated last month that the historical record shows oil bulls are taking a big bet that the world is heading for 1970s-style stagflation (high inflation and low, or negative growth), or that the developing economies have such rapacious appetites for the stuff they will pay anything for it.

Energy is a valid long-term investment theme, but oil is set to tumble in the short term. Speculators are tying up huge amounts of physical oil as collateral to cover their long positions on forward contracts. This is a big contributor to the current supply/demand imbalance.

• Global economic growth is slowing but is proving extraordinarily resilient given the credit crisis and persistently high energy prices. Monson points out that in the US, corporate earnings in the first quarter (excluding financials) grew 11.5 per cent year on year and that 66 per cent of companies beat analysts’ expectations. As Monson says, it shows that ‘the global growth outlook has not yet shown any of the aggressive deterioration so clearly expected by the doomsayers’.

• The credit crisis is not a globalised problem. In aggregate, global official short-term interest rates, at 4.2 per cent, are negative, because global inflation is running at 5 per cent. And these ‘easy money’ conditions do not factor in the liquidity-boosting initiatives introduced by central banks nor the $117 billion (£60 billion) tax rebate winging its way to US taxpayers. Recent figures (see Flashback, page 16) show just how resilient the US consumer can be.

• By just about any measure, global equities are exceptionally cheap. On one measure – the bond-equity premium – valuations are at a 30-year low. A sharp reduction in corporate earnings is already priced into shares. And if that fails to materialise, we can look forward to some fireworks as investors realise things weren’t as bad as everyone made out.

Monson concedes that high oil prices will curb investors’ enthusiasm for shares in the short term, and that summer will probably need to pass before it becomes prudent to lace up the buying boots.

So investors who sensibly have stayed invested in shares should sit tight. Their day will come. But if you are waiting for sustained signs of improved sentiment you should note the figures from the table below (a year old but just as valid today), which show how difficult it is to time markets.

Had you invested £1,000 in UK shares in June 1992, 15 years later they would have been worth £4,612, with dividends reinvested. But if you stripped out the 10 best trading days (out of roughly 3,500) on the stock market, the value would fall to £3,041. Had you been unlucky enough to miss the best 40 days your £1,000 would be worth a paltry £1,304.

Just ask yourself how many ‘crises’ we have experienced in those 15 years. Then ask yourself: is it materially different this time?


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