For IFAs and investors it seems that there is no end to this equity bear market which has been going on for over three years. In the short term, nobody should expect any sustained rally in global stockmarkets and I think we are set to see more swings up and down, albeit in a narrow range.
Once any war with Iraq is out of the way, I think we will start to see solid progress in the major stockmarkets. In my view, many overvaluations have now corrected and bad news on the corporate earnings front is pretty much out of the way or at least factored in if it is still yet to come.
However, my interpretation of solid is average annual growth over the medium to long term in the region of 7 to 8 per cent, although I do think certain stockpicking funds will be able to add, say, 2 per cent to this figure.
Despite this prolonged bear market, it is worth noting that it is only equities that have posted losses over the past three years. Any sensibly diversified investment portfolio would have benefited from strong returns in fixed interest and property and, of course, competitive cash accounts have also held their value.
In the three years to December 31, 2002 the average returns from the IMA UK corporate bond sector was +18.49 per cent, the IMA property sector delivered +22.63 per cent and the IMA money market sector also posted a respectable +11.03 per cent (Standard & Poor's, bid to bid, net income reinvested). Three out of four asset classes have performed well, which underlines the importance of asset class diversification.
So, with the Isa season upon us the big question is where should people be invested? I think the answer to this question is simple – everywhere. I am wholly convinced that the most robust strategy for any investor with an investment timeframe of five years or more is to have exposure to all four asset classes. Further to this, I believe that geographic diversification should be built in to any equity exposure.
The pattern of investment returns over the next few years will be different from that of the last few years. I think that equities will outperform corporate bonds and property but at some point the cycle will turn again and because I do not believe anybody can successfully call the top or bottom of any cycle.
Emerging markets typically trade on lower valuations than their developed counterparts, and the management of companies has improved significantly over the years. The bigger companies are typically well run operations and I think when investor confidence does return, this is a geographic area that could post returns ahead of the major world markets.
The post-Enron improvements in the US's accounting systems will undoubtedly help to enhance investor sentiment but I expect we will still see more skeletons fall out of the cupboard over the next 12 months or so. It seems likely that the US is also going to have to deal with budget issues stemming from the cost of the war with Iraq. Added to this its equity market valuations are expensive relative to other major markets. The bottom line for me is that the US is unlikely to be the strongest performer in any stockmarket upturn.
The recent cut in interest rates should help to keep the UK economy on a safe footing and it even seems that, at last, the housing market is cooling off. I think there is real value in the stockmarket right now and the yields on equity income funds are testament to the relatively low level of valuations. However, one big problem for many FTSE 100 companies is the increasing scale of pension fund shortfalls in their final-salary schemes. Dividend cuts seems likely, but I think that, on balance, the market still looks reasonably attractive.
I think investment-grade corporate bonds will hold their own in the short-term but they have limited prospects given that interest rate cuts and the flight from equities to bonds is, in my view, fully factored in. High yield, on the other hand, could well join in any equity market recovery and, therefore, I think the best strategy for investors is to have some exposure to both types of bonds.
In terms of its short-term prospects I think commercial property is in the same boat as investment grade corporate bonds. In certain sectors of the commercial property market, such as offices, some rents are actually falling. And as the actual value of a commercial property is simply a function of its yield a falling rent means a falling yield which means the capital value must fall to compensate. In the short-term, I see commercial property funds delivering competitive income yields, but capital growth is possibly on hold for now.