At a time when stock markets have been at their most volatile and economic activity so unpredictable, forecasting how stock markets are going to perform is proving to be even more difficult than usual.
Some things may well go up in 2009 — the UK savings ratio, unemployment, government debt, gilt issuance, bankruptcies, the number of capital raisings, and the cost of holidaying abroad, especially in the eurozone and the US. Conversely, other things may be heading in the opposite direction — profit forecasts, house prices, interest rates, some dividends, LIBOR spreads, and, probably, investor enthusiasm for equities.
Whilst we may hope that the extremes of the 2008 stock market volatility may ease over the next 12 months, it remains probable that equities are going to continue to rise and fall in narrow trading bands throughout 2009.
These movements may well be accompanied by some sharp rotations within the market as sentiment towards industrial and resources stocks, for example, remains heavily dependent on expectations for global growth.
Similarly, there may be periods during which the more domestic names either rise or fall as attention shifts back and forth between potential interest rate cuts and the inevitable raft of poor trading statements.
In these trading conditions, it is important to retain a medium to long-term investment horizon, and to continue to view ‘bad days’ in the market as an opportunity to exploit the relatively short-term nature of equity markets by adding to stocks at depressed levels. Indeed, with share prices often driven by sentiment and recent trends, as opposed to a realistic assessment of the longer-term picture, the resulting volatility often creates considerable valuation opportunities.
Perhaps the most important question for 2009, is to what extent the ‘guaranteed’ factors, both positive and negative, that we mentioned above have already been priced in to UK shares.
Undoubtedly, the UK economy will have a very tough time in 2009 and a lot of companies will not survive.
That said, UK share prices have dropped to such an extent over the last 12 months (exacerbated by the unwinding of leveraged positions) that many valuations have now hit an extremely distressed level.
This is highlighted by the fact that many UK companies with strong balance sheets, sound business models and good long-term prospects are currently trading on just three to five times this year’s earnings.
One could argue that this leaves many shares priced not just for a recession, but a depression, and thus, on the most likely scenario of recession until 2010, leaves UK equities looking undervalued on a three to five-year view.
There are a number of important things to look out for in the year ahead.
Key is the extent to which interest rates continue to fall and, most importantly, the degree to which lower rates begin to ease funding difficulties for banks, companies and individuals.
Given the levels of outstanding debt needing to be refinanced, it is critical that the price and availability of credit eases.
Central banks and governments across the world have now at last moved from fighting inflation to fighting the deflationary impact of the credit crunch and much hangs on the success of their moves to cut rates, rekindle investor appetite for corporate bonds and, more controversially, expand government spending.
The success of China in boosting its growth rate again through monetary and fiscal means will be an important focus for investors as well.
Another important consideration will be the US housing market, where any signs through the year of stabilisation will be central to improving sentiment about the impact of distressed US assets on banks around the world.
Intense interest will be shown in US President-elect Obama’s plans for tackling the downturn when he settles into the White House later this month.
Taking all the above into consideration, the key for the UK equity market is for investors to see sufficient justification to look forward to a resumption in UK and global growth during 2010. Regardless of how subdued that growth may be, that expectation will be crucial in terms of returning some degree of clarity to the market over the coming year and, if that can be achieved, we may well see a pick-up in UK share prices over the course of 2009.
Brian Craig is senior investment director at Rensburg Sheppards Investment Management in Belfast