Pitching optimism: Fund company says stocks looking better

(July 24, 2003) The equity markets are primed for growth and anyone left behind in fixed income are likely to get burned, according to the optimists at Franklin Templeton Investments.

“There’s a lot of cash on the sidelines, which to me makes it very bullish, because that cash will find its way into permanent investments,” says Donald Reed, president and CEO of Franklin Templeton and lead manager of Templeton International Stock Fund. “I do know that the institutional investors are putting additional money into equities at this point in time, based on my experience in the institutional marketplace.”

In recent months the global economy has faced several crises, including the Iraq conflict and the outbreak of severe acute respiratory syndrome. Reed also points out that in Canada, there has been concern over mad cow disease, but with all these problems fading into history, positive signs are emerging. He points to improvements in corporate governance and, perhaps most important, positive corporate earnings.

In the past quarter, Reed says 62% of companies surpassed expectations, with 22% meeting predictions.

Those recent results have led to some favourable valuations on the market, according to Fred Pynn, lead manager of Bissett Canadian Equity Fund.

“The markets are looking very attractive. The bad news about equities is already in the equity price, all you need is a bit of a shift where maybe people start losing money on bonds,” Pynn says. “The inverse of the [price to earnings] multiple has now gone above the interest rate on a 10-year Government of Canada bond yield and you can also look at dividend yields and come up with the same conclusion.”

But retail investors are still gunshy of the stock market, preferring to hold onto their fixed-income securities.

“After three years when the markets have been pretty lousy, our sense is that people have become very jaded toward investing in equities,” says Pynn.

So how can a financial advisor convince their clients to consider equity investing again?

“I think the valuation argument is pretty compelling right now that the equity market is still relatively out of favour and, given how low interest rates have gone, equities are offering potential for good rates of return,” Pynn says.

Pynn also points out that many clients may have let their portfolios become overweighted toward bonds, income trusts and real estate. This overallocation can be just as dangerous as the overweighting toward equities in the 1990s.

“Think about asset allocation. You’re supposed to be at your maximum equity allocation at the bottom of the market and at the minimum at the top. Of course, people do the exact opposite,” says Pynn. “I’m sure there are people out there that swore off equities and have all their money piled into money market funds, bond funds… but as we know, when interest rates go up, interest-sensitive security investing comes to a screaming halt. Meanwhile the markets have made a pretty good move off the bottom.”

A more comfortable way to ease clients back into the equity markets may be to start with the safer, less threatening end of the spectrum. Blue-chip stocks with healthy dividends might be an easier transition from bonds.

“There are dividend yields available well in excess of money market yields, comparable to two- to five-year bond yields,” Pynn says. “You’re buying these companies that have the potential for dividend growth over time, whereas with bonds, the coupon is fixed. You have to start that process of coming out of your bomb shelter, look at your asset allocation decisions and having a long-term asset mix that makes sense.”

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Filed by Steven Lamb, Advisor.ca slamb@rmpublishing.com

(07/24/03)