Threadneedle believes value still available despite ongoing volatility

Alex Lyle, Threadneedle’s Head of Managed Funds comments: The credit crisis moved on another stage at the weekend with the dramatic rescue of Bear Stearns by a combination of the U.S. Federal Reserve and J.P. Morgan. This will clearly have a negative impact on confidence and the availability of credit which is detrimental for economic growth and equity markets. However, there are some positive aspects which should not be ignored. First, the action by the authorities, particularly in the U.S., to boost liquidity and avoid a banking failure have been swift and aggressive - underlined by yesterday’s 75 basis point Fed rate cut. Secondly, recent figures on inflation from the U.S. have shown signs of improvement and the oil price has fallen from its peak. This reduces a constraint on the central bank’s ability to cut rates. Finally, and crucially, equity valuations are attractive. In difficult times, when earnings can be hard to forecast, the dividend yield is one of the best indicators of tangible value in a market. Currently the historic yield on the UK & European equity markets is over 90% of the yield on the respective 10 year government bonds. It is very unusual for equity yields, approaching 4.0% in the UK and around 3.6% in Europe, to be so close to government bond yields. Dividends in both regions are, in general, well covered, companies have sound balance sheets and we expect dividends to rise. If we look at the global price/earnings ratio, it is currently at the lowest level for 15 years. We forecast low single digit global profit growth this year but we do expect levels of corporate profitability to remain high. In summary, while the volatile environment is likely to continue for some time, we believe equities offer value for medium term investors.

Our funds have benefited over the last six months from focusing our portfolios towards strong companies with healthy balance sheets and an ability to grow in the current environment. We also have a preference for larger companies and companies in less cyclical areas. We believe it remains essential to retain this defensive position against the background we see today.

Government bonds have benefited from slowing economic growth, falling interest rates and a general flight to quality. While yields are likely to remain low, given current uncertainties, we see little medium-term value. Higher risk bonds, including investment grade, high yield and emerging market bonds are all offering increasingly attractive spreads over government bonds. We believe the likely risks are fully discounted and these asset classes will show attractive returns over the medium term. However de-leveraging by vehicles holding these bonds has pushed spreads higher and this process could well continue for some time.