Time for bulls to set off on the long run: The market decline may be over but bearish fears of a further fall can help to create an opportunity for patient investors

THE SETBACK in share prices, and even more in bonds, during 1994, has given investors an opportunity to buy long- term financial assets at reasonable prices.

The yield on bonds has risen from close to 6 per cent to a recent peak of 9 per cent. On shares, as measured by the FT- SE-A All-share index, the yield is around 4 per cent, against nearer 3 per cent in February. Both are yielding well, ahead of the rate of inflation.

This weakness reflects fears among many observers that prices are going to fall further. There has even been talk of another October crash in share markets should the US Federal Reserve raise short-term interest rates again. But investors should remember that it is precisely these widely held bearish views which create buying opportunities.

The keypoint about stock markets is that shares always recover to new peak levels eventually. The mistake so many investors make is to wait until that has happened before buying. The best time to buy is when a decline seems to have run out of steam. The risk is of buying into a rally before a further and perhaps more serious decline takes place. Even then, the long-term investor who picks his shares wisely should do well, but will be kicking himself for missing an opportunity to buy at even lower prices. Seasoned investors spend most of the time kicking themselves, but still do well overall.

I believe the 1994 setback has run its course and that shares will now rally.

The September setback, although quite sharp, was on very low volume. A market strategist I used to write about (now deceased) said all significant stock market moves ended in double tops or double bottoms. The second peak or trough might appear to reach new peaks or plumb new depths, but was typically on lower volume. Add the volume to the index level and the double peak or trough was apparent. On his analysis, the UK stock market (and probably also the gilts market) has made such a double bottom. Final confirmation would come from an advance above the recent rally peak of 3270 on the FT- SE 100 and a decline in bond yields below the 8.25 per cent reached when bonds rallied in July.

Further encouragement for bullish investors comes from the fundamentals. The economy appears to be set on an export-led and investment-led recovery, with consumer spending and inflation remaining subdued. Kenneth Clarke, the Chancellor, will surely want to come up with good news on the public sector borrowing requirement in his late-November budget, if only to create room for tax cuts in the run-up to the next election. Lower long-term interest rates would be even more helpful.

There is a well-established pattern for the autumn to be a good time to buy shares. Also, since 1989, good and bad years have succeeded each other in the stock market. On this simple rule, 1995 should be a good year.

On a more sophisticated level, there is scope for a resumption of capital flows from Japan. In 1994, a tap pouring money at dollars 100bn a year or more into world markets was turned off partly as a consequence, and then as a further cause, of the strength of the yen. If the probably overvalued yen starts to weaken, Japanese investors could return in force to buy hard-currency bonds, on what to them are spectacularly attractive yields. This would be good news for bond and share markets.

Investors have a choice between piling into FT-SE 100 shares or choosing some attractive second-liners. The former are likely to respond more quickly, with the best ultimate gains coming from the latter.

My preferred choices among blue chips at present would be BAA at 508p, Lucas Industries at 195p, Vodafone at 208.5p, Royal Bank of Scotland at 415p, RTZ at 885p, Whitbread at 546p, Unilever at 1144p, TI Group at 369p, Thorn EMI at 994p, Shell at 727p, Rentokil at 233p, Reed International at 770p, Marks & Spencer at 419.5p, Johnson Matthey at 556p, Granada at 520p, GKN at 606p and Siebe at 544p.

Altogether they make a balanced portfolio that should do well in the long run even if in the short term the market collapses. If it storms ahead, they should fully reflect the gains.

Liquidity-challenged readers could shop within my selection without upping the risk significantly. More cautious investors could invest some money now and a further tranche if the Americans do raise short- term interest rates again.

The choice among second- liners is enormous, because so many are trading well. Some ideas would include Abbott Mead Vickers, the advertising agency, at 668p, CPL Aromas, the mini-flavours and fragrances specialist, at 193p, Vinten, the global television equipment supplier, 504p, whose chairman once told me that a half-way decent worldwide recovery would send profits through the roof, and James Halstead, the floor coverings and rainwear manufacturer, at 380p. Also looking attractive is Huntleigh Technology, the medical equipment maker, at 420p, whose chairman, Rolf Schild, said at the time of the recent excellent results that his factories were working flat out.

Others include Morland, the regional brewery, at 515p, with one of the best long-term records in the stock market, Serco, the contracting-out specialist, at 288p, and such fund management groups as Perpetual at 1150p and Edinburgh Fund Managers at 695p.

Sage Group, the accounting software specialist, at 605p, has added to its attractions by buying a group supplying packages for larger companies, First Choice Holidays, 115p, the renamed tour operator, which said at its recent AGM that it was beginning to win back lost market share. Plant and equipment hire groups including Ashtead at 447p and Hewden Stuart at 153p are doing well, and a remarkable recovery is taking place for long-suffering shoe retailers, such as Stylo at 165p and Oliver at 94.5p.

The best speculative play in the stock market for the recent rally was nil paid shares in Unichem, the fast-growing pharmacy wholesaler, after its recent rights issue. In three days they went from 10p to 25p. Reckitt & Colman nil paid shares have also done well, reaching 46p from a low of 24p.

An alternative for investors looking for that sort of excitement would be to buy out-of- the-money FT-SE 100 call options. Prices are quoted on Ceefax and Teletext or in the Financial Times. As an example, the January option giving the right to buy the FT-SE 100 at 3200 costs 81p. This will close with a profit, before trading expenses, if the FT-SE 100 hits 3281 in January.

But it will also show a quick profit if the market continues to rally over the next few days. Equally, there is a risk of losing most of your money if the rally boils over.

(Photograph omitted)