More Value in Equities than Bonds

But to get ahead of the curve will require a touch of the ‘flexible and pragmatic’ referred to by the Fed’s Vice Chairman and that means a half point cut.

Bond markets have been driven by a flight to quality and the prospect of lower interest rates and they are now overbought. The short end of the US Treasury market is discounting a sizable reduction in the Funds rate to around 3 percent or thereabouts. In our last note (see Gearing Up for a Year End Rally in Equity Markets! 29^th November 2007), we made the point that equity markets are the likely beneficiaries of a move out of bond markets. The latter are discounting so much in the way of interest rate cuts already, are technically overbought and therefore due a bout of profit-taking.

Bond/equity earnings yield ratios have materially improved in favour of equity markets by virtue of the flight to quality in the bond markets. In the case of the S&P 500, this valuation ratio is at its lowest point in the period shown in the chart. The equity market offers great value relative to bonds if you believe that the earnings expected by the consensus for next year can be achieved. As we have been saying for a while, this seems an unlikely prospect but we’ve also been saying that, even allowing for earnings downgrades and providing the US economy is not about to enter an horrendous recession, there is still value in the equity market.

Given that equity markets remain oversold, there is good reason to believe that the stage is set for them to rebound into the New Year.

*The information contained in this report has been taken from public sources and is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. The opinions expressed in this document are not the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents. We or a connected person may have positions in or options on the securities mentioned herein or may buy, sell or offer to make a purchases or sale of such securities from time to time. In addition we reserve the right to act as a principal or as agent with regard to the sale or purchase of any security mentioned in this document. Prices, values or income may fall against the investor’s interests. You should therefore be aware that you may get less back than you invested. Past performance is not a guide to future performance. If you are in any doubt concerning the suitability of these investments for your portfolio, you should seek the advice of a qualified investment adviser.