Beyond The Pessimism Some Reasons To Be Optimistic In The Face Of Market Challenges

 

After a dismal summer, and an even more dismal fall, it seems likely world stock markets will experience their third consecutive year of losses - something that hasn't happened in a generation.

 

Despite the challenges faced by world economies, there are some positives about the longer-term outlook for equities. Here's a brief review of some of the convincing arguments for optimism when it comes to the equity markets.

 

Equities Now Undervalued

 

It's perfectly normal for bonds and equities to experience large, multi-year swings in relative performance. Stocks can dramatically outperform bonds for several years, after which, bonds outperform stocks. We have now just been through one of the most severe swings in favour of bonds.

This is good news for stocks. According to the Fed model (which compares the estimated earnings yield of equities to the yield on 10-year government bonds), equities are now undervalued by some 32% against bonds (see chart). Unless the U.S. heads into a prolonged period of deflation (an unlikely scenario), equities should outperform bonds in the coming years.

 

So the question remains: is there a way to generate good returns and protect the portfolio while we wait for a turnaround? Here are some quick thoughts:

 

Diversify Your Portfolio

 

A diversified portfolio not only boosts returns, but it can protect investors from short-term volatility.

 

Investigate The Business

 

A share is simply a portion of an underlying business. Before making any decision to buy stock, investors need to review a company's balance sheet.

 

Go With The Pros

 

Professional money managers are better able to assess risk and make allocation decisions. Those looking to preserve and build their capital should put their money with the pros.

 

No doubt about it: global markets still face considerable challenges. Risk management will remain the number one priority for investors for some time. But as serious as the challenges may be, global economic conditions are a lot better than the current market suggests. By maintaining our investment discipline, we can use the downturn to our advantage, and seize opportunities others have ignored.