This is a tricky time for investors. Returns from equities have been disappointing over the past year despite the fact that markets have bounced from their March 2001 lows. Equally, cautious investors who have retained their funds in cash have seen returns eroded by significant falls in interest rates.
Unless you have been nimble enough to spot the rise in the gold price, it has been very difficult to make money from the markets. Even property is now showing signs of peaking, so where is the sensible place to invest?
I am not alone in finding the markets difficult to call at the moment. Most leading strategists were far too optimistic in 2000 and, like the Federal Reserve, were slow to spot the speed and severity of the economic downturn in the US. Economic growth there looks set to fall from around 5 per cent in 1999 to around 1 per cent this year, due mainly to the bloodbath in the telecoms and technology sectors.
It is interesting to compare the performance of the major equity markets in recent years to discover whether any int-eresting trends can be detected. US equity markets have been consistently strong while Japan and Asia Pacific have been the most disappointing. But it often seems to be the case that a market which does well one year slips down the rankings the next, highlighting the need for geographical diversification rather than committing too large a sum to one particular market.
Moving this argument on to the area of specific sectors, technology was the top performer in four of the past seven years. However, technology and telecoms saw sharp underperformance in 2000, with the best returns coming from the healthcare sector, which had itself disappointed in 1999. Again, this highlights the need for diversification across sectors, since no one area of the economy can deliver consistent outperformance.
There are plenty of reasons to be optimistic about the long-term outlook for markets despite the current uncertainties. Taking the example of the UK, interest rates are set to fall further and shares look relatively attractive against bonds as long as the inflation outlook remains benign.
In Japan, Prime Minister Koizumi has been elected on a reformist platform and, although recent economic figures were disappointing, people hope he will be able to break some of the blockages within the Japanese economic system.
In the US, growth will undoubtedly pick up next year, tax cuts will have a positive economic impact and consumers will keep on spending.
Significantly, and sticking with the example of the US, a recent piece from Morgan Stanley has shown that on the 10 previous occasions since 1945 when there have been five consecutive interest rate cuts, the equity market has always generated a significant return during the year following the final cut. In addition, there is a strongly held view that mid-March represented the low point for the US and other equity markets.
Therefore, the optimists say the interest rate cuts will ensure there is a worthwhile pick-up fairly soon. However, there is a contrary view – one which does not quite go as far as “sell in May and go away” but which says we are in for a long dull summer and that investors will have to be patient before becoming rich again. It pains me to say it but I have some sympathy for this approach.
Investors tend to become more risk-averse over the summer. Simply put, corporate news is often relatively quiet, people are on holiday and it feels too early to start establishing positions with the year end and the year ahead in mind. Investors tend to remain liquid and keep their portfolios fairly defensive.
I believe we are unlikely to see strong signs of a pick-up in the US economy until later in the year. Indeed, the first quarter's annual growth figure has just been revised down and the interim results season will see further earnings downgrades. It will take several months for interest rate cuts to feed through into stronger profits although, equally, equity markets tend to bottom around seven months before the trough in earnings is reached.
Pulling these comments together, and in the expectation that the US will start to see signs of recovery in the late autumn, I expect equities to start making progress at or around that time, with a similar theme being repeated around the globe.
One slight problem is that equities are not outstandingly cheap at the moment, so the recovery is likely to be fairly muted. However, with interest rates at historically low levels, a combination of dividend yield and capital growth should ensure that equities will start outperforming again.