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Rally round

Equity markets have rallied hard from extreme pessimism and oversold levels in early March and there has been some recovery in the credit markets, with prices hardening and spreads narrowing as liquidity returns. The turn-round has been remarkable but have investors cast aside their pessimism too quickly?

The S&P 500 has rallied nearly 30 per cent from its low on March 9 to the end of April. Investors took encouragement from some improved economic data and aggressive policy action by the authorities.

The economic data remains gloomy. Japanese exports have halved and UK car sales are down almost a third. GDP figures have tended to disappoint but there is hope the speed of the correction in output and inventory de-stocking could lead to improved or not as bad as expected figures. However, this is posited on a pick-up in demand, which may not occur if there has been a secular shift in consumption in response to unemployment or people saving more.

Nevertheless, there is a feeling that the systemic threat from the financials has passed and the world now has to contend with the traditional fallout from a recession. Most eyes will be on the direction of US house prices. Any signs of bottoming could signal we are through the worst. The Case-Shiller US house price index was showing an acceleration in pace of decline but this has moderated recently. Several lead indicators are showing marked improvement. ECRI’s US Long Leading index has been advancing for several months which would traditionally indicate the seeds of a recovery while the G7 Purchasing Managers New Orders index has climbed sharply.

The equity market tends to discount recovery so it should start rising ahead of the economic event. Several technical indicators have moved up through moving averages, particularly the Asian indices, which could provide momentum in the near term. Consequently, we have been increasing exposure to this region.

We have been looking at long-term valuations. For investors with a medium or long-term investment horizon the big sell-offs in the equity markets and the credit markets over the last two years have created plenty of value. We have been gently building a position in US smaller companies to gain exposure to areas of the market that have heavily sold off and could be poised for recovery. At these levels, we believe the markets provide a good entry point for the medium to long-term investor.

Mark Harris is director of funds of funds at Henderson Global Investors

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