One of the most common comments I hear investors say is that they don't want to take their savings out of their deposit account until they can see things are getting better.

Are they right to wait?

 

If things were never going to get better then may be they are right. But in this scenario they should really be buying Government Bonds as these are the safest. There are however a number of basic facts to consider which will probably draw you to another conclusion.

 

Sentiment

What about the current market situation. There has been an improvement in general investor sentiment but it could hardly have been any worse last winter when investors were worrying about the survival of almost every bank and the potential collapse of the global financial system. However whilst sentiment has improved , it is generally still weak. As a result both private individuals and investment managers are sitting on record levels of cash. Some of this will be in Fixed Rate Bonds taken out last summer/autumn when you could still get a decent rate.  These will mature soon and will be offering a much lower interest rate for a new term. Much of this is likely to look for better returns and much of this cash could filter back into Equity and Corporate Bond markets. Improving sentiment is always good for markets.

 

Economic News

There appears no doubt that a Depression has been averted and whilst news is still bad, it is not getting worse. We have witnessed recently better than expected job loss numbers in America and economic growth figures from China and Australia. The extent of the massive global stimulus dwarfs any previous government spending and it is going to continue. As a result it is only time before economies recover. Of course, I think we are in for a period of slower growth and austerity but that is still positive.

 

Valuations

Whilst share prices have risen from the depths reached in winter they are still generally attractive. The Price to Earnings Ratio (PE) for the FTSE 100 is still below 10, a level that in the past has been a good time for investors to enter the market. Looking at the last 36 years every time the UK Stock Market has been at a PE of 10 or below it has produced a return of over 10% p.a. over the next 10 years.

 

Another strong indication of value is the Gilt to Equity yield ratio. Currently for the FTSE 100 it stands around 1.0 which means that you receive the same income from a 10 year Government Bond as you do from the average share in the market. Normally you would expect a higher return from Gilts because they offer no potential for growth and the capital value is being devalued by the effects of inflation. Shares on the other hand are expected to grow dividends over time. Recently there have been some major dividend cuts, especially from the banks but most of these are now factored in. Surprisingly at the moment the market is not giving a premium to good companies that are still raising dividends. As a result there are some very attractive dividend yields of over 6% being offered by household names such as Aviva, BP, National Grid, Shell and Vodafone. With interest rates so low funds investing in this type of company will surely do well. Funds in the Equity Income sector must surely come back in to popularity.

 

The outlook for interest rates is also very supportive of Equity investing. Interest rates are unlikely to rise at all this year and when they do eventually go up the Bank of England along with other central banks will be very careful not to raise them too fast in case they undo all their recent efforts. So expect an extended period of low interest rates.

 

Of course this could lead to inflation in the longer term but real assets such as Equities, Property and Commodities tend to perform well in such periods. The main losers if inflation does appear will be investors who leave their money in Deposit accounts and Government Bonds.

 

From a technical point we appear to be in a consolidation phase at the moment. The FTSE broke up above its 200 day moving average in early May which is a bullish signal. However the index itself is still falling and will not turn upwards until July at which point it could signal the second stage rally in a new bull market.

 

In conclusion if you are thinking of investing in the Equity Markets, now is a good time to do so. If you wait until markets start to rise you could miss a substantial rally. Two years ago today the FTSE 100 was 6732. As I write it is 4366. To go back to where it was could see a rise of 54% in capital and do not forget, all those lovely dividends you will get as well.

 

This blog is the personal view of David Stephenson as at 16th June, and does not constitute professional advice.