Global stock markets have behaved in a relatively benign fashion since the beginning of the year, particularly when taking into consideration the considerable hurdles they have overcome. Sadly there has been nothing that will inspire investors who are sitting on cash to re-introduce money into the stock market. A period of digestion after the strong run at the end of 2010 was to be expected. The most important question now is: which stock markets will perform most strongly over the next six months?
Even against a back drop of economic uncertainty, UK equity prices (and equity prices more generally) look attractive. We believe the negative sentiment is fully priced into UK stock market valuations and we emphasise the international nature of many UK listed businesses. There should be a mismatch between the performance of the UK economy and the valuation of the UK stock market if we look at where many of our UK listed businesses derive their profits, but all too often media headlines scare off potential investors. We predict a strong run for the FTSE 100 led by global franchises while domestic and Government related businesses are left behind. In the short to medium term, we are very happy to introduce more money into the UK stock market.
Our medium to long term focus remains the emerging markets. From a current valuation perspective, however, the UK looks more attractive than many emerging market stock markets. Brazil, India and China have had a disappointing first half. Valuations reached a fulcrum point where, in our view, investors were better placed to put their money into businesses listed in the developed world and operating in these emerging markets rather than investing directly in the emerging markets.
In many ways, the emerging markets have become a victim of their own success. Their allure grows when our newspaper columns are full of stories of troubles in the developed world: another financial institution in trouble, fallible politicians, a fall in real disposable income, another soft patch in Western economies. But stock markets react to this news and we believe that, more often than not, they are an efficient pricing mechanism. So, whilst it may be right that the emerging markets are more expensive (because that is where the growth will come from in the medium to long term) there is a short term opportunity to buy certain UK equities at attractive prices.
Looking forward, we hope the second half of 2011 will be more rewarding. There doesn’t need to be a catalyst as such, just a realisation that equity valuations are attractive and offer much better returns than nearly all other asset classes. It is not surprising that equity valuations are low; a decade of disappointing returns for mainstream equity indices, continuing economic headwinds and the introduction of new asset classes have all served to divert investor attention away from the equity markets. However, the current low interest rate environment is favourable for equity market performance and we expect to see an increase in investment flows among private investors and a sustained period of good returns.
