Secrets Of Success: More than one reason to be cheerful

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The Independent Online

It is now more than four years since the end of the bear market. Four years in which the FTSE 100 has bounced off its low of 3,287 and risen 94 per cent to hover around 6,400, little more than 500 points off the all-time high of 6,930, reached at the end of the last millennium.

During this time, most investors will have made healthy gains, and if you had invested with a good fund manager, you may have been lucky enough to have doubled the index's return.

There have, of course, been a number of corrections along the way, which, in my view, are quite normal and desirable. No one likes to see markets go down, but, as a professional investor, I view these pauses for breath as a welcome reassessment of market conditions and valuations. I would, in fact, be more concerned if markets were not to suffer the occasional setback.

I am, however, intrigued at the effect that these corrections seem to have on private investors. The most recent correction, which started in February, resulted in a frenzy of "shock horror" headlines in the newspapers, suggesting that we could be on the verge of another bear market. This seems to be one of the key reasons, along with rising interest rates, why Isa sales across the industry in February were 40 per cent below last year's levels.

The fact that markets have now regained all the ground they lost during this temporary setback, or that an investor who did decide to invest their Isa at the low point would be looking quite clever now, having gained almost 7 per cent, has not, of course, generated the same media interest.

This episode serves to prove that memories of the bear market of 2000-2003 are still driving investment decisions, even to the point where investors seem happier investing in commercial and residential properties, which are looking increasingly overvalued, rather than in equities, where the prospects for further gains are attractive.

Why do people have this irrational fear of markets? There must be something hard-wired into our brains that causes us to instinctively fear a repeat of the losses we have already made, while remaining blind to the risks, such as in property, in front of us.

However, this irrationality represents an opportunity for those of us who recognise it, and instead of worrying about short-term sentiment, can focus on the likely prospects for markets, which I believe are encouraging, in the medium to long term.

When asked what markets are going to do, I often quote the physicist Niels Bohr: "Prediction is very difficult, especially if it is about the future." I offer you my thoughts on that basis. Looking at the fundamental backdrop, I believe that we are in a period where economic growth is slowing from historically strong rates, but that doesn't mean we are heading for a recession - at least not yet. Perhaps more contentiously, I do not believe that we are likely to see sharply rising inflation, as we remain in a period in which we are benefiting from cheap imports from the emerging economies of India and China. We should, however, be prepared for limited rises. Interest rates are likely to remain relatively low as a result - personally, I believe that we are close to a peak in interest rates in various parts of the world, such as the US.

So, the basic economic fundamentals appear reasonable, but what about company valuations? Markets may have had a strong run from the lows of 2003, but if you look at historical P/E ratios, you will see that earnings per share growth in the UK since the market peaked in 1999 have grown by a cumulative 68 per cent, from 2000-2006, leaving the market on a forward P/E of 12-13 times to the end of 2007. This compares with a forward P/E of 23 times at the end of 1999. These numbers tell me that UK stocks have de-rated, and that there is still value to be had in equities.

My view that equities remain good value is supported by the continued presence of mergers and acquisitions, particularly from private equity firms, in the market. There has been plenty of criticism of private equity houses buying out British companies in recent months. But my view is different. Having worked in private equity myself before joining Jupiter, and having just teamed up with a private equity company ourselves to buy our business from Commerzbank, I believe that private equity ownership can be highly beneficial - companies tend to emerge from the private equity "gym", as I like to term it, in a far fitter state.

Another reason to be cheerful is that company balance sheets remain in good shape. While I would expect more profit warnings going forward, profits growth is likely to remain healthy among high- quality companies, and cash generation will continue to be high. This bodes well for dividend growth - good news for the rising tide of income-seekers we will see in the future.

In addition, equities look good value relative to other asset classes. If you look at the accompanying bar chart (below left), you can see that, while equities have performed well during recent years over the medium term, they remain the underdog, having gained just 3.2 per cent between 2000 and the end of 2006, compared with 13.2 per cent for investment property and 12.6 per cent for houses.

Looking more broadly at the key themes that will drive the global economy, and investment returns in future, I would identify four: the development of the new economic powerhouses of Brazil, Russia, India and China, together with other emerging economic forces such as Pakistan and Vietnam; new technologies; ageing populations; and, of course, climate change.

So, while there are always risks, whether from protectionism or geopolitical tensions, there are good reasons why equities should produce better returns going forward than cash, bonds, or property.

Edward Bonham-Carter is chief executive of Jupiter Asset Management.

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