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Investment view

October. Month of mists and mellow fruitfulness. And if it is October, it must be time to head to the West Country again. Sadly, my Port Isaac retreat had gone the way of all flesh but I consoled myself with a trip to Rick Stein&#39s Seafood Restaurant. Excellent food but prices more Pimlico than Padstow. Given the state of the market, it is a wonder I could afford it.

It was the state of the market that I was tackling when I met with independent financial advisers in a variety of locations down in the South-west. A remarkably sanguine bunch they all were although there was evidence that the damage wrought by this bear market is significant.

One insurance company representative admitted that, while he had some trouble meeting his targets, provided he concentrated on corporate bond and property funds with the odd with-profits thrown in, things were not too bad. But pure equity investment was simply not in demand. No wonder the market is in such disarray.

It is worth touching briefly upon the message delivered to those good advisers in Devon and Cornwall. The theme was “When would the bear market end?” The answer was that I do not know.

But some aspects have become clearer as this bear market progresses. The valuation expansion we saw in the 1990s, justified on the basis that low interest rates and low inflation demanded a higher price for equities, was clearly false. In the end, low inflation will limit profit and dividend growth, so any premium accorded to equities is likely to be less rather than more.

The belief, too, that technology as a sector was unaffected by economic cycles has also proved ill founded. Technology turns out to be just as vulnerable as any supply side industry. Indeed, this situation is probably worse, given that significant overcapacity was built up in that long bull market. No wonder CMG and Logica are getting together, a marriage borne more out of weakness than strength.

But the problem remains that it is difficult to judge the right price for equities. A healthy share market is crucial as free and transparent capital markets are essential ingredients in the capitalist mix. In the end, the risks that equity investment entails must carry with it the promise of greater returns than those achievable from more predictable markets, such as Government debt.

However, some established theories are being turned on their head. The reverse yield gap, as an example, has collapsed. The yield on gilts is just one and a quarter times that on equities. Given that the recent average has been two times or so, this suggests that equities look very cheap compared with bonds. But look back further and you will find that the reverse yield gap was once a yield gap – with equities yielding more than bonds to reflect the greater risk they carried.

While the ability of well-managed companies to increase dividends should demand some yield discount for equities, the thought of us returning to a situation where equities yielded half or less than the yield on gilts no longer looks sustainable.

Last week remained difficult for investors and managers alike. There was little in the way of good news although the prospect of a bid battle for Abbey National will have brightened the day for traders. Perhaps the real change is that, for many, the direction of the market no longer matters so much. The fact that it is moving at all is sufficient.

Indeed, volatility has been increased by the activity of those now prepared to short the market, either through derivatives or using spread betting. Investment may never be quite so straightforward again.

Among the week&#39s entertaining reading (which did not include market reports) was an article on the wisdom of one Harry Browne, a “leading investment adviser” in the US with 30 years experience and 11 books under his belt.

I beat him on years of service but fall way short on book publication. Among his tips are that nobody can consistently time the market. Yet that is what clients all too often expect. Investing, he says, is accepting the market return. I will go along with that but trying to judge what that return is likely to be is proving difficult.

Still, if timing is such a problem, perhaps equity investors should fall back on pound/cost averaging. Thank heavens I did not cancel my savings plan.


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