The Fundamentals Remain Strong For Equities

10.06.10

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The markets have suffered a number of mainly politically induced hits recently. Sovereign debt fears about the southern Eurozone countries reverberated across the globe. There were concerns over

The markets have suffered a number of mainly politically induced hits recently. Sovereign debt fears about the southern Eurozone countries reverberated across the globe. There were concerns over what impact banking reform in the US could have on the banking sector and broader financial markets. In Germany, the government suddenly and unexpectedly announced a ban on naked short selling.

The markets react badly to uncertainty and in a panic reaction many investors sold out of equities and other assets. When this happens, low risk assets tend to rise in price and riskier assets fall as a result of this risk aversion induced flight to quality.

At times like this, however, investors need to look beyond the short-term bad news and fear induced market falls, and look at company fundamentals.

John Velis, the Head of Capital Markets Research at Russell Investments, said at the beginning of June:

?In the long term, we remain committed to the fact that the fundamentals are extremely strong for equities.

?In the reporting period just completed, earnings in the US were exceptionally strong and it was already expected to be a good results season- in the end it was even better than expected. There?s no reason to think, short of the world plunging back into fears of a real double-dip recession, this risk aversion will prevail in the long-run.?

An Aberdeen Asset Managers communication on 26th May warned that debt and geo-political problems could be around for some time and markets could potentially suffer more falls in the short-term. More austerity measures and in more countries could be implemented over the summer. However, it also spoken encouragingly on company fundamentals –

?As hard as it might be, if investors focus purely on company fundamentals they will generally find them in good shape around the world. Post-crisis, weaker players have been crowded out, balance sheets have been strengthened and management have refocused on their core businesses. Regardless of domicile, credit and equities remain attractive, particularly from issuing companies whose earnings are linked to structural growth (rather than economic activity) and/or have an international client base offering exposure to emerging markets where economic growth will remain strong.?

Aberdeen Asset Managers also said that current Euro and Sterling weakness may also encourage further cross-border M&A (merger & acquisition) activity as companies look to take advantage of ?cheaper” prices?; European exporters should benefit from its currency?s decline and the amount of liquidity available, due to low interest rates, should support equity and credit markets over the next year or so.

Looking at the US, its gross domestic product (GDP) is a healthy 3%. Aggregate US corporate profits are impressively up over the last year, with a broad rise across industries. Over January to March, US corporate profits from reporting companies increased 30% year-on-year for the second quarter in a row.

Yearly earnings growth of over 30% has only happened six times since the S&P 500 series began in the 1950s and historically bodes well for shares. Five out of these six instances, the index went on to rally between +10% and +33% over the following 12 months. 1959/1960 was an exception, but it still broke even.

Both the International Monetary Fund (IMF) and Organisation for Economic Co-Operation and Development (OECD) have recently revised their 2010 global economic forecasts upwards.

The OECD forecast was particularly encouraging, coming as it did at the end of May against a backdrop of fears. The organisation appears confident that positive forces are likely to outweigh negatives ones. Their forecasts imply that the Eurozone problems are not enough to hinder global economic growth.

The sovereign debt crisis will be an ongoing concern for the Eurozone, but it should not halt growth completely. Last November the OECD had forecast 0.9% growth for the Eurozone this year and 1.7% next year. At the end of May it increased these projections to 1.2% and 1.8% respectively.

While austerity measures will impact on European economic growth, at the same time it will be supported by a weaker Euro and emerging markets.

Emerging markets are in strong health compared to developed countries. They have lower fiscal deficits and do not need to implement the austerity measures we are seeing in some western countries, so consumers are in a better position to spend. The weak Euro will make European exports more attractive to the growing middle classes and European exporters will continue to benefit from the expected continued emerging market growth.

For those with capital available to invest, the fact that share prices have fallen presents a good buying opportunity provided you can take a long-term view and are prepared to ride out short-term volatility. When prices have fallen many investors view the asset as being riskier, but in fact as their value falls, the risk attached to them also falls.

If you wish to protect the buying power of your wealth then, based upon your investment objectives, timeframe and attitude to risk, you could consider investing in a balanced and diversified portfolio including equities, bonds, property and cash. It is important to take professional and authorised advice from a company such as Blevins Franks Financial Management Ltd.

By Bill Blevins, Managing Director, Blevins Franks

4th June 2010

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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