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Investment view

Popular wisdom used to be that the equity market was the best home for long-term savings. Ordinary shares were often viewed as a gambling counter and the province of the very rich. It was the wholesale move of pension funds into the equity market in the 1950s and 1960s that led to a reassessment. The logic was simple. Good companies raise their profits most years and pay higher dividends. What better reason for owning shares if you are a long-term investor?

This approach was given considerable credibility during the long bull market that embraced the 1980s and1990s. Aside from increasing economic prosperity, the stockmarket went through a period of valuation expansion. The price investors were prepared to pay rose significantly. To be fair, valuation expansion has taken place before. The entry of pension funds as major investors in the stockmarket in the 1950s created a similar situation. Interestingly, during both periods, the valuation accorded to ordinary shares pretty much doubled.

The most common measure used to determine the value of a share is the price/earnings multiple. Simply expressed, it represents the number of years a company will take to earn its present share price at its current level of profitability. Between the beginning of the 1980s and the end of the 1990s, the p/e ratio of the London market moved from an average of 12 to 24. This was not entirely without justification. The period also encompassed a time when both inflation and interest rates fell significantly and appeared to adapt to these lower levels with reasonable stability. With bonds and cash yielding less, it seemed reasonable to pay more for ordinary shares.

But now it has all been turned on its head. Ordinary shares are locked in negative territory, with investors becoming increasingly nervous and the greater transparency afforded to many investment vehicles leading to a realignment of portfolios to embrace asset classes with more predictable returns, such as bonds. This has been particularly true of insurance company and pension funds, where the need to demonstrate adequate resources to meet future liabilities has led to some fairly dramatic rebalancing. The result has not just been to enhance the performance of bonds compared with equities. The FTSE 100 recently recorded its first-ever drop over five years.

Then there is the greater volatility that exists, certainly within individual shares but arguably for markets as a whole. In part, this is due to technology allowing information to be speeded ever faster to those who influence price movements, while complex financial products can also exaggerate price movements when news dictates a change of opinion.

The investment world has become more professional. While nearly 60 per cent of ordinary shares in the UK were owned by private investors in the early 1960s, perhaps as much as 90 per cent will today be at the beck and call of professional managers. Good fund managers are the stars of the City but are also rare. The more mediocre majority were once somewhat unkindly dubbed “pinstriped sheep” by a City editor. This change needs to be recognised by investors.

Years ago, a handful of blue chips would have been all you needed to bask in the glory of a bull market. Today, much greater care has to be taken in selecting investments and changing a portfolio. Buy and hold strategies no longer work. Witness the fall from grace of shares that were household names, like Marconi and Marks & Spencer, although, with the latter, the recovery has been just as dramatic.

Markets spiralled down dramatically following the September 11 tragedies. These are the types of event that every investor has to realise can occur without warning. It does nothing to help restore the confidence presently lacking. The game may not be over but it most certainly has changed.


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