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Home > Opinion > Philip Coggan

Buyers must be brave, but equities represent strong value

History suggests long-term returns from buying equities at these valuations will pay off.

By Philip Coggan | Published Jun 25, 2012 | Investments | comments

The world economy seems to be slowing.

The “canary in the coalmine” is commodity prices, with the S&P GSCI index down 16 per cent from its level of a year ago. Brent crude is back below $100 a barrel.

The sluggish state of the European economy is well known. The US economy is not showing the strength it was displaying during the winter, which may have been caused by unusually mild weather. The big surprise has been the slowdown in commodity imports by China, although there was a bit of a rebound in May. The Chinese have cut interest rates for the first time in several years, a sign that the authorities are concerned ahead of the leadership switchover at the end of the year.

The “canary in the coalmine” is commodity prices, with the S&P GSCI index down 16 per cent from its level of a year ago

Lower prices should, by themselves, act as a bit of a cushion for consumers. They are already showing up in the form of better inflation numbers. The US headline rate is down to 1.7 per cent, and UK input producer prices – what businesses pay for supplies – are flat year-on-year.

But it seems highly likely that governments and central banks will take more action. In the UK, chancellor George Osborne and Bank of England governor Mervyn King have unveiled plans for credit easing, lending money to banks which will be lent on to the corporate sector. If Greece does exit the euro, the European Central Bank seems likely to open the monetary pumps in order to limit the damage. The Federal Reserve has made it clear that it will act again if the US economy slips further.

For equity investors, the prospect of further monetary action provides a potential measure of comfort. Interest rates will stay at rock bottom levels for the foreseeable future. And, outside the European periphery, it seems likely that long-term bond yields will also be very low – yields on two-year German bunds have at times been zero. As a long-term bets, these look pretty terrible deals. It is only fear of a eurozone collapse that is generating willing bond buyers. Eventually, those investors will go in search of higher returns and when they do equities, along with corporate bonds and property, will be the beneficiaries.

In the short term, the news from the corporate sector is unlikely to be that great. Société Générale strategist Andrew Lapthorne calculates that, in the US, earnings upgrades have fallen from 58 per cent of all estimate changes to just 44 per cent in the last month. There is a risk that companies will batten down the hatches, decide against making new investments or ordering extra supplies until the outlook becomes clear. Such caution often turns out to be self-fulfilling.

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