Darkest before the dawn


Is the recent pick-up in several major stock markets more than just another short-lived rally?

The latest headlines are not often the best indicator of the direction of the market, as investors look to the future while economic statistics focus on the rear view mirror. They can tell different stories at the same time.

Dominic Rossi, Fidelity’s Global Chief Investment Officer for Equities, has been bearish on equities for the past 18 months or so, believing correctly that shares were unlikely to go anywhere as long as there were large and unquantifiable obstacles to their progress in the form of the banking, economic and sovereign debt crises.

So I was intrigued when he recently told me that he now sees growing evidence for cautious optimism on the part of equity investors.

The thrust of his argument is that the key risks to equity markets – bank deleveraging, policy inaction and political risk with regard to Europe, and commodity prices – have all now been recognised by investors and so priced into the valuation of markets. It is not that they have disappeared – they haven’t – but their capacity to shock the markets has been dramatically reduced.

As investors have taken on board all the myriad problems facing the global economy they have positioned themselves accordingly.

As any contrarian investor knows, generalised distrust of a market like this is very often the trigger for a rally. Only when you get to this stage have all those wishing to exit the market already done so. When no-one wants to invest in equities any more there are no more sellers to drive prices lower.

Dominic points to a handful of reasons to be positive. He points to interest rates, which have been declining for some time, and more generally to expansionary monetary policies which have pushed the yields on longer-dated bonds to very low levels. This, in turn makes a compelling case for equities because, across the board, they now offer higher dividend yields than their respective bond markets.

Another reason is a technical one: markets have shown signs over the past few months of finding support at key levels. There is an unwillingness to push prices lower. This has reduced volatility.

Finally, and this is the most interesting point I think, the leadership of market rallies has changed. Markets are no longer being led upwards by sectors that traditionally do well when confidence returns – like commodities and banks – but by mainstream sectors like consumer discretionary, pharmaceuticals and technology, relatively dull sectors with steady dividend streams that offer investors a store of value.

In other words, investors are buying shares for the right reasons, because they offer income and security rather than the promise of a quick return.

When you look around the world, there is a huge amount of value available in these types of companies.

Does this mean we are out of the woods? Absolutely not.

There are still considerable risks – a slowing economy in China, the yawning budget deficit in America and the ongoing eurozone crisis to name just three very obvious ones.

But importantly the reasons to sell equities have become the conventional wisdom and that is very often a great time to start thinking of reasons to buy them instead. 

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. Prior to making an investment decision, retail investors should seek advice from their financial advisers. Investors should also obtain and consider the Product Disclosure Statements (“PDS”) for any Fidelity fund mentioned in this document. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise.  2012 FIL Responsible Entity (Australia) Limited.  Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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