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Why we believe this bull market has much further to run

Richard Troue explains why the pessimistic mood amongst investors gives us confidence about the prospects for the stock market.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

In the latest edition of the Investment Times, Mark Dampier describes the period since 2008’s financial crisis as “the most unloved bull market” of his career. He thinks there is the potential for further gains in 2017 and beyond. The reason, partly, is so many investors are still negative - unjustly so in our view. There is a lot of evidence to support this.

Low confidence can be a good sign

Since 1995 we have conducted a monthly survey of investor confidence. Over the course of 2016 this showed investors becoming ever more cautious. There were notable dips in the aftermath of the Brexit vote and US election. Overall confidence is around all-time lows - levels not seen since the financial crisis itself and in 2011, when there was talk of Greece exiting the euro.

Investor confidence often hits a low point just before a stock market bounce. To ignore the perceived wisdom of the crowd and take a contrarian view can be unnerving. However, it often pays off in the long run, as the chart below shows. Please remember there are no guarantees and past performance is not a guide to the future.

Past performance is not a guide to future returns

Source: HL, May 1995 - December 2016

The lack of confidence among the investing public is borne out in the types of fund they are buying. Targeted Absolute Return funds have proved popular. These funds are typically more cautious, aiming to deliver positive returns in any market conditions with lower volatility than a traditional fund. This means they usually underperform when markets rise strongly - investors’ pessimism can lead to lower long-term returns.

In contrast, the UK All Companies sector has often featured as the least popular. In October 2016, for example, investors withdrew over £720m from the sector. This compares with £426m of inflows into the Targeted Absolute Return sector.

Most popular sector Least popular sector
Oct-16 Targeted Absolute Return UK All Companies
Sep-16 Global UK All Companies
Aug-16 Targeted Absolute Return Specialist
Jul-16 Targeted Absolute Return UK All Companies
Jun-16 Global Bonds Property
May-16 £ Corporate Bond UK All Companies
Apr-16 Targeted Absolute Return UK All Companies
Mar-16 Targeted Absolute Return UK All Companies
Feb-16 Targeted Absolute Return UK All Companies
Jan-16 Targeted Absolute Return Mixed Inv. 20-60% Shares
Dec-15 Targeted Absolute Return Mixed Inv. 0-35% Shares
Nov-15 UK Equity Income Short Term Money Market

Source: Investment Association, 28/11/16

There are signs of caution among professional investors too. A recent survey of global fund managers by Bank of America Merrill Lynch suggested their allocation to UK shares remains well below its long-term average. Again we view this as a positive sign - if sentiment towards the UK improves, institutional investors will increase their allocations and this buying pressure could drive the market higher.

Cash on the sidelines

The same survey also highlighted historically high cash balances among the fund managers surveyed. Fund managers tend to hold cash if they are cautious and waiting for better opportunities to emerge.

A large amount of cash on the sidelines means should markets fall by, say, five or ten percent, the dip could be heavily bought. We saw this with the Brexit referendum and around the US election, where market falls were quickly reversed.

Even though cash levels dropped after the US election they remain higher than at virtually any time over the past 10 years.

The only game in town

Finally, it is worth considering that few, if any, places beyond the stock market offer the potential for a decent investment return. UK interest rates stand at 0.25% and we don’t see them rising in the foreseeable future. Any future rises are likely to come in small increments, with rates ultimately likely to peak well below historic levels.

Bond yields also remain around historic lows - approximately 1.3% on UK government bonds and approximately 2.8% on corporate bonds.

The UK stock market on the other hand currently yields 3.4%. Beyond cash set aside for a rainy day, we think the stock market offers a good home for investment capital. Indeed, some good-quality equity income funds yield in excess of 4%. Yields are not a reliable indicator of future income.

There are risks, Brexit chief among them, and your capital is not guaranteed, but at these levels we believe investors are well-rewarded for the risk. Even if dividends are cut, yields are still likely to look attractive. If you're investing capital that you don't need in the short term it shouldn’t matter if the value fluctuates while you wait for the potential for long-term gains - providing you are happy with the additional risks.

Our conclusion

You might think the combined intelligence of a group would lead to good decision making, and the views of so many professional and retail investors were worth taking note of. However, when it comes to investment it often pays to ignore the ‘wisdom’ of the crowd and take the contrarian view.

UK companies as a whole look fairly valued, and in many cases have excellent prospects. With plenty of cash on the sidelines earning negligible returns, and pessimism rife, we remain bullish in our outlook for the UK stock market.

Five shares for 2017 - our analysts select five companies they believe can thrive this year and beyond

The information in this article is not intended to be personal advice. If you are unsure of the suitability of an investment for your circumstances seek advice. Unlike cash investments will fall as well as rise in value, so investors could get back less than they invest. Past performance should not be seen as a guide to future returns.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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