In a world of uncertainty - the bull case for equities

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There are various headwinds that are giving investors cause for concern at present. Top of the 'worry list' is political uncertainty in the form of Donald Trump and Brexit, while from an economic standpoint the spectre of rising levels of inflation haunts both bond and equity markets.

There are, however, ways investors can inflation-proof their portfolios, as Money Observer highlighted last October.

The chart below (click to enlarge), from Goldman Sachs Asset Management, shows that towards the end of 2016 the word 'uncertainty' in news articles reached record levels.

But as far as markets are concerned the Trump era is good news, provided he can push through his various economic pledges.

REASONS TO BE FEARFUL

Failure to do so will in all likelihood lead to a market correction, a view that has been expressed by various fund managers, including Sam Morse, manager of the Fidelity European Values and Fidelity European funds, and Richard Buxton, who heads up the Old Mutual UK Alpha fund.

There are other reasons to be fearful. Mitchell Fraser-Jones, head of investment communications at Woodford Investment Management, cautious about the medium-term outlook for the global economy, due to high debt levels, rapidly ageing demographics and a lack of productivity growth.

chart-of-uncertainty

Other risks on the horizon include China's credit bubble popping, while another concern is the prospect of Europe moving further to the right of the political spectrum, with a handful of elections taking place this year, most notably in France and Germany. Both countries have eurosceptic political parties that have been gathering momentum.

But despite all the macro concerns when investors go back to the drawing board and take a look at valuations, UK equities look reasonably priced rather than out and out expensive, despite both the FTSE 100 and FTSE 250 recently registering record highs.

Research by Fraser-Jones, in a recent blog post, looked at the starting valuation of the UK stock market, in terms of its price/earnings ratio (p/e), at the end of every year since 1974.

EQUITIES AREN'T BROKEN

At its peak UK equities reached a p/e of 28.6 times (x), while the cheapest entry point was in 1974, when the market carried a p/e of 4x. Today the UK stock market's current p/e is about 15x for this year's anticipated earnings.

The valuation today is firmly in the middle of the long-term average. A p/e of 15x implies a real annualised return of around 8 per cent over the next decade.

'This isn't bad, in our view, especially when compared to the likely returns available from other asset classes,' says Fraser-Jones, who adds the caveat that 'market returns may well disappoint from here'.

'Lacklustre growth from the global economy over the next few years may mean returns from the UK stock market from here are better in the second half of the decade than in the first half. Importantly, however, we don't believe that the equity asset class is broken,' he adds.

'It is, of course, as essential as ever to be selective. Even in the dotcom bubble when the overall market was ludicrously overvalued, there were cheap stocks. Genuinely active fund managers were able to find ways to make attractive returns even though the broader UK stock market stagnated for the best part of a decade.'

As ever it is worth remembering the art to successful investing is to 'buy low' and 'sell high', rather than the other way around.

Darius McDermott, of fund ratings service FundCalibre, named the Asia ex Japan region as an area that should be on the radar of investors who are looking for undervalued assets. He adds UK microcaps also look cheap, with shares in this part of the market trading on a 10 per cent discount to the FTSE 100.

Funds McDermott favours in Asia include Schroder Asian Alpha Plus, Matthews Asia Pacific Tiger and Stewart Investors Asia Pacific Leaders. The latter is a Money Observer Rated Fund.

McDermott's microcap recommendations are: Marlborough UK Micro Cap Growth, also a Money Observer Rated Fund, Wood Street Microcap and Liontrust UK Micro Cap.


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