October gives punters reasons to be cheerful

Investor/An insider's guide to the market: Investment returns for October have been a little mixed, but in general investors will probably be reasonably content.

There are still many investors who remember October 1987 when global equity markets suddenly crashed. Indeed, historically October has been a difficult month for equity markets so that the modestly positive returns set out in the table will be generally welcomed.

In fact, given the unsettled economic and political backdrop the small advances made by most equity markets in October is impressive. During the month oil prices moved decisively above $50 per barrel, fuelling concerns about global growth going into 2005.

There have been some recent signs that oil prices may have peaked, but it is far too early to assess whether prices will retreat from current levels. On the political front the US presidential election race became locked in a dead heat according to the opinion polls.

Geopolitical events continued to have the potential to upset the markets, particularly given the deterioration in the conflict in Iraq.

Despite some downgrading of growth prospects due to the rising oil price, many companies reported strong profit growth during October.

Technology and telecommunications companies came to the fore with several reporting surprisingly strong financial results.

The highlight was the Google report, which was well received by the market and led to a sharp increase in the company's share price. Google's share price is now trading at double the level at which they were issued in its controversial initial public offering.

Another factor that helped equity markets during October was a shift in expectations regarding short-term interest rates. It had been generally assumed that global short-term interest rates would continue to rise slowly but steadily for most of 2004 and into 2005.

Now, however, opinion has become more diverse. In the UK the housing market has suddenly come off the boil, leading many commentators to conclude that sterling interest rates may have already peaked.

In the US most economists still expect the Federal Reserve to raise short-term interest rates further, but it is now anticipated that such rises will be spread over a much longer period of time.

This more benign view of interest rate trends has been reflected in further declines in the yields offered by long-term government bonds.

Irish 10-year bond yields are now as low as 3.8 per cent and US 10-year treasuries are yielding 4 per cent.

In the UK the equivalent yield is somewhat higher at 4.7 per cent.

With interest rates and bond yields so low, any company share that offers a good dividend yield looks very attractive. For example, most of the Irish financial stocks offer an historical dividend yield of approximately 4 per cent, and these dividends should grow in line with the overall growth in the economy in the long run.

Therefore, it does seem as if the combination of robust corporate profitability and falling bond yields was sufficient to outweigh the negative impact of oil prices on equity market sentiment during October.

With only two months to go in 2004 the year-to-date returns from the main market indices are barely in positive territory.

Dividend income adds 2 per cent to 3 per cent to this capital appreciation so that on a total return basis 2004 could still be a good year for equity investors if there is even a modest year-end rally.

For investors in the Irish market, 2004 looks certain to be a good year, given the year-to-date gain of 15.5 per cent in the ISEQ Overall index.

The stellar rise of 275 per cent in the Elan share price accounts for about half of the rise in the index. Excluding Elan the ISEQ is up by approximately 7 per cent in the 10 months to end-October.

When dividend income is taken into account Investor continues to hold the view that a full year return of over 10 per cent is in prospect for the ISEQ (excluding Elan) in 2004.

Even if there is a year-end rally the final column of the table presents some sobering data on how far equity markets remain below their respective all-time peaks.

At the end of October the S&P500 was 26 per cent below its all-time peak, while the FTSE100 was one-third below its peak. On this yardstick the Irish market is in much better shape given that it is now only 11.9 per cent below its peak.

These figures show why there is still a lot of scepticism regarding equity markets, although the optimists will point to the upside potential inherent in equity markets if they can regain previous all-time highs.

Irrespective of the eventual outturn in 2004, investors are already focusing on 2005 and will be hoping that the world economy can continue to grow at around its potential rate of growth.

If an optimistic assessment emerges in coming weeks then stock markets should finish the year on an upbeat note.