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Hargreaves Lansdown Share Research

  • Of employers to have adopted auto-enrolment, 6,155,000 workers remain on the sidelines
  • Stock market and confidence move in opposite directions
  • Investors wary of a ‘peacock market’
  • However stock market valuation remains near its historical average
  • Investing in times of low confidence has delivered strong returns
  • Options for cautious investors

The Hargreaves Lansdown Investor Confidence Index fell 13% to a new record low of 59 points in November. This is the lowest level seen since the index began in 1995. The previous low of 61 points was recorded in March 2008. This compares to a record high of 129 in January 2004.

Of the ten worst months in the index’s 21 year history, three have been in this year, though despite low confidence, the FTSE All Share has returned 13% so far in 2016 and in October reached a record high.

This divergence is probably down to the widespread concern that central bank policy has distorted asset prices, and has led to a ‘peacock market’, which is all puff and no substance.

It’s true that the price put on the UK stock market has moved up ahead of earnings in recent years, however valuations are still close to their historical average, and are way below the euphoric heights witnessed in 1999.

The November HL Investor Confidence Survey was conducted between 1st and 7th November. It therefore reflects the period leading up to, but not including the result of, the US election.

Laith Khalaf, Senior Analyst, Hargreaves Lansdown:

"So far in 2016 investors have been buffeted by a commodity collapse, the Brexit vote, and most recently the US election, so it is little wonder they are feeling cagey right now.

The conundrum however is that the stock market and confidence seem to be moving in opposite directions. There is some sense in this because as stock price rise, investors become more wary of a subsequent fall.

This is probably exacerbated at the moment because central bank policy has made investors suspicious of a peacock market, which is all puff and no substance.

However while there is some truth to this characterisation, and the valuation put on the UK stock market has undoubtedly risen as a result of monetary easing, it is still near the middle of its historical range. This suggests it is not a bad time to invest if you are in it for the long term.

Moreover monetary policy looks set to remain supportive for a considerable time to come, and the Bank of England is unlikely to change tack until economic growth is more robust, which should in turn help company earnings.

Times of low confidence can often be opportune moments to enter the market, however daunting that may seem. Meanwhile there are still plenty of options for more cautious investors who want to save for their future.

Setting up a regular savings plan is one way to enter the market gradually, while automatically taking advantage of any dips to buy in at lower prices. Cautious investors should also consider conservative funds which aim to shelter them from the worst of any stock market falls that do materialise

With cash rates so low and inflation coming back into the system, investors need to explore all the tools at their disposal to get a decent return on their money."

The "peacock market" – stock valuations and QE

Despite a long bull run in the UK stock market, there is still plenty of fear, uncertainty and doubt out there. Commentators and investors alike are wary of a ‘peacock market’, where stock valuations have been inflated by central bank policy, in particular Quantitative Easing, which has driven bond yields down.

The current P/E (price/earnings) ratio on the UK stock market stands at 19 times earnings, compared to a long run average of 14.1 time earnings. However the cyclically adjusted P/E ratio (CAPE) currently stands at 15.7 times earnings, compared to a long run average of 19.4 times.

(This latter measure looks at earnings over the last ten years, and so places less emphasis on more volatile short term effects, such as the annus horribilis experienced by oil and mining companies over the last 12 months).

The first of these measures suggests that the market is slightly overvalued, the second that it is slightly undervalued, but importantly in both cases the deviation from the average is not out of the ordinary. Together these two measures suggest the UK stock market is neither cheap nor expensive, it is somewhere in the middle.

When monetary policy goes into reverse, there could be some erosion of the valuation attached to stocks, however there looks little prospect of this change of policy direction at the moment.

When interest rates do eventually rise, it is likely to be a slow and gradual process, accompanied by economic growth, which should be supportive of company earnings, and so stock prices. Unless, that is, the Bank of England finds its hand is forced.

Investing against the grain

Like any good contrarian investor, Warren Buffett recommends being greedy when others are fearful, and fearful when others are greedy.

If we look at this in the context of the UK stock market, it is noticeable that investing in the stock market at times of pessimism has delivered strong returns. The table below shows the annualised returns from the UK stock market to the end of October, starting from the end of the worst months for investor confidence.

Three of the lowest ten readings of our Investor Confidence Index have occurred during this year, and returns from these months are too short-lived to be meaningful. Looking at the worst ten readings before this year therefore, two things stand out.

First, annual returns from investing in the stock market since these readings have so far been strong, ranging from 5.3% to 13.0%, and averaging 9.4% compared to a long run average of 7.5%

Second all of these low readings all come from during or after the financial crisis. Indeed since 2007 to the present day, the HL Investor Confidence Index has averaged a reading of 95, compared to 105 in the period 1995 to 2006. Even excluding the worst years of the crisis, confidence since the beginning of 2010 has averaged just 96.

This suggests that since the worst of the crisis the stock market may well have climbed, but the wall of worry is still there. The good news is that a wall of worry is preferable to the irrational exuberance witnessed in the late 1990s, and these readings suggest the rise in the stock market may be in part down to loose monetary policy, but it’s certainly not down to animal spirits getting out of control.

Month HL Investors Confidence Index FTSE All-Share Annualised Total Return to 31/10/16
Dec - 2007 68.8 5.3%
Jan - 2008 71.5 6.5%
Mar - 2008 61.1 6.7%
Dec - 2008 69.4 10.9%
Jan - 2009 63.6 11.9%
Feb - 2009 69.1 13.0%
Nov - 2011 64.1 9.7%
Dec - 2011 67.9 9.7%
May - 2012 61.2 11.0%
Aug - 2012 68.9 9.6%
Jun - 2016 66.9 N/A
Oct - 2016 68.0 N/A
Nov - 2016 59.1 N/A
Average bottom 10 before 2016 66.6 9.4%
Long run average since 1995 100.2 7.5%

Options for cautious investors

While being contrarian is a sensible strategy for more adventurous investors, some are simply more comfortable with a more cautious approach.

For investors in this category, there are a number of options available to them. One way of smoothing out volatility is to invest in the stock market on a monthly basis, which means automatically buying on any dips.

Another strategy is to invest in funds which take a conservative approach, with a focus on capital preservation and sheltering you from the worst of any market falls. Two such funds are Newton Real Return and Pyrford Global Total Return.

Finally whatever approach you take, conservative or adventurous, make sure your portfolio is sufficiently diversified, so you don’t have all your eggs in one basket, and if you are choosing active funds, make sure they are run by quality stock pickers.


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