BLOG: stock markets look cheap, but will they get cheaper?
Some of my family have already bought their presents for next Christmas. Nowadays though, there are several sales throughout the year, so it’s hard to know whether this is the cheapest chance you’ll get to buy your presents. The same applies to equity markets. Since the summer equities have been on sale. But will there be an even cheaper opportunity to buy them?
While valuations have fallen, corporate earnings expectations for the FTSE100 and US stock markets have barely budged. So while the price to earnings ratio has fallen, the earnings haven’t yet fallen. If you believe company earnings will keep growing over the next few years then the lower prices available now look attractive. If however, you think earnings could fall in the next couple of years, then prices could fall further even if price to earnings ratios just stay where they are. Of course valuations could also fall further, as earnings fall.
I worry that with the unemployment rate as low as it currently is in both the US and the UK, that if history is anything to go by, the probability of there being a recession in the next couple of years is rising. Low unemployment tends to lead to wage gains and hence higher interest rates, which slow the economy down. While UK interest rates remain low, in the US they have been rising. With that in mind, stocks could get even cheaper.
Brexit complicates matters further, a no deal Brexit would have significant negative repercussions for the UK economy, while a deal would lead to a rally in the pound. As many UK listed companies make most of their money abroad, a stronger pound means their foreign earnings would be worth less to UK investors.
Investors might therefore want to consider having a more balanced portfolio, still with some equity exposure but also with some investments which can hopefully rise in value if equities fall further. These might include US government bonds (with the currency hedged), targeted absolute return funds and perhaps a small amount of gold. Within the equity portion of a portfolio it is worth considering stocks which already look cheap but that are quality businesses that can withstand a recession. Some stocks are sometimes cheap for a good reason, and could be worth avoiding. This quality and value approach to equity investing could outperform other equities if the economic outlook deteriorates, while a well balanced portfolio should help to buffer overall returns whatever happens.
In short, I’ll probably be doing my Christmas shopping next winter.