Investors face dilemma to run, walk or buy - FT.

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August 5, 2011 7:13 pm

Investors face dilemma to run, walk or buy

By Aline van Duyn in New York and Matthew Vincent in London

Just hours after the US markets closed on Thursday one investor sent around the following e-mail: Run, Walk ... or Buy? The question posed by Jim Paulsen from Wells Investment Management encapsulates the dilemma facing investors around the globe. In just two weeks, the main US stock indices have lost more than 10 per cent. This performance is echoed in most other big stock markets. At one point on Thursday, when share prices plunged on Wall Street, a feeling of near panic took hold. The speed of the declines in US stock prices this week was even faster than the sell-off on the day Lehman Brothers collapsed nearly three years ago. Are stock markets now headed for another sustained plunge, or is the drop in prices a chance to snap up bargains? Mr Paulsen remains a bull, and is urging investors to buy. His case rests on the fact that, by historical standards, stocks are very cheap. First, on an absolute basis, the prices of stocks are trading at low multiples of earnings. For the benchmark S&P 500 index, the 12-month forward price to earnings ratio is at 10.3 times, well below the average of 15.2 times for the past 10 years. Second, relative to government debt, where yields on benchmark US Treasuries reached new lows this week, stocks look cheap too. The dividend yield for the S&P 500 is 2.2 per cent versus a yield of 1.2 per cent on five-year US Treasury debt. Unless the US economy is indeed headed for an imminent recession, the absolute and relative stock market valuation appears very attractive, Mr Paulsen says. The difficult issue is that the path of the US economy and that of the broader global economy, for that matter is particularly tricky to map out. Indeed, this is one of the reasons that the risk premiums associated with stocks relative to government debt or cash investments are so high, and may go higher still. It is unclear what central bankers and governments can do to lift flagging growth. Many of the market rallies since the crisis have followed action taken by policymakers, such as central bank moves to pump cash into the financial system and government moves to pump money into economies through stimulus plans. Now, three years into the crisis, the options for policymakers are more limited. The fall in equities, despite their much better value than bonds, shows that investors are seeing much greater downside risks on stocks, says Jan Loeys, chief market strategist at JPMorgan Chase. One reason is a growing concern that policymakers have run out of bullets and are thus unable to stop the rot. Adrian Lowcock, senior investment adviser at Bestinvest, suggests waiting for government intervention before moving into stock markets. In our opinion, equities are decent value, he says. Unfortunately, theres no reliable way to predict whether markets have yet found a base. The further equities fall, the greater the chance that more quantitative easing occurs or that European authorities are galvanised to provide a credible solution to the debt crisis. The views on the prospects for equities vary across regions, however, and there are fund managers who continue to favour investments in markets such as China and India that are not as directly exposed to the sovereign debt strains engulfing Europe and weighing on the US. Fidelity International says Asian and emerging markets are already looking oversold, compared with developed markets, given their faster-growing economies and lower debt levels. Fund manager Anthony Bolton, who runs the groups China Special Situations investment trust from Hong Kong, argues that, in Asia, a bull market in equities will soon resume. I believe the recent stock market volatility reflects a familiar pattern during this bull market of short, but often very sharp setbacks, within a bull trend, he says. This makes the case for exposure to developing markets and particularly those of Asia even more compelling where growth rates by comparison even though they are slowing will still be very attractive. History shows that normally extreme equity market volatility, as we are now experiencing, should be seen as a time of opportunity rather than a time to become more defensive. Some fund managers are already rebuilding positions in developed market income stocks, on valuation grounds. Mark Burgess, Threadneedles chief investment officer, says: I do not know if this marks the low of the equity markets, but I do

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Investors face dilemma to run, walk or buy - FT.com

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know that valuations are low and companies are strong financially. In UK equities, the dividend yield on the market is now 1 per cent higher than on 10 year gilts a valuation anomaly I have never seen before. He says his funds bought more UK equities on Friday. Indeed, it is the record low yields that are on offer in government bonds and the near-zero interest rates which are a reality for investors holding cash that may prompt investors to keep money in stocks or other risky assets, despite concerns about the potential for future falls. There are some bulls out there, but the majority of investors who hold decent sizes of equity portfolios do so primarily because the alternative is so poor, says Mr Loeys. It is expensive to be defensive.

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