In doing so the hope of the authorities was that the gap between official and money market interest rates would narrow, thereby stimulating demand for new credit. Unfortunately, that’s not the way things have panned out, as investors instead turned their attention to developments within the Eurozone, and the lack of a co-ordinated approach to the funding crisis. As a result, the FTSE-100 index plunged a further 7.9% yesterday to 4589, its lowest close since October 2004.
But the question we should be considering is whether such lowly valuations are now justified? We recognise that the demise of a number of household names within the banking sector almost by definition must have driven up the equity risk premium; in other words, everything else being equal, the return required above the so-called risk free rate to induce investors to hold equities has increased. However, the flip side of the latest equity market sell off is that valuations have moved even further into “buy” territory. Indeed, as at the close of business on Monday, the dividend yield ratio on the FTSE All Share Index had fallen to its lowest level since 1957, a period that pre-dates the cult of the equity.
But is this a fair reflection of how the UK equity market should be valued? Ostensibly, with the ratio down to 0.86, the indicator is telling us that gilts with no potential whatsoever for income growth are currently more highly valued that equities. This cannot possibly be right for the UK equity market as a whole beyond anything other than the very shortest possible time horizon. Admittedly, by itself this won’t necessarily preclude equity markets from becoming even cheaper in the short term, but providing we aren’t looking at the end of the capitalist system as we know it, we remain confident that equity markets will be substantially above current levels in 12 months’ time. Unfortunately, we can’t pin-point more precisely when the recovery will begin. Nevertheless, for those investors who are willing or able to look through the short term volatility, we remain convinced that October 2008 will prove to have been an excellent time for investment in global equity markets.