So the question should be focused not on the level of equities, but on the time frame of the investor and the level of risk that the investor is prepared to take.

Long view reduces risk

Investors with only a short time horizon, who are drawing down capital from their portfolio or who are nearing a major decision point, such as approaching retirement, should reconsider whether the long-term balanced portfolio is right for them.

However, as a starting point for long-term investors seeking to grow the real (net of inflation) value of their portfolios, a high allocation to equities remains a valid strategy while being cognisant of the following core risks:

• annual volatility in share prices reflects the mood of investors from day to day. • that future company earnings do not grow at a sufficient rate over time. • that the price paid for anticipated earnings streams is too high.

The positive tailwinds for earnings growth over the past 30 years are unlikely to be repeated and, accordingly, equity prices should be correspondingly lower.

But how much lower? The price at acquisition remains the strongest indicator of future long-term equity returns. This arises simply because investors consistently and incorrectly extrapolate recent trends in earnings growth. Today, huge write-downs have led to pervading investor pessimism. But businesses adapt – that is the nature of capitalism. And pessimism provides an opportunity. There is comfort that today’s global-equity valuations effectively assume little or no earnings growth for the next decade.

In short, the case against equity investing does not stack up for investors with a long-term horizon.

Today, the pricing of equities is attractive, even though the forward economic environment looks much more difficult than it has been for the past 30 years. As businesses respond to what is likely to be a much tougher operating environment, there will inevitably be varying periods of investor gloom or even panic as investors focus on annual profit announcements, restructures and adverse political events.

Investors should only make significant changes to equity allocations when they have a strong view that there is fundamentally incorrect pricing. Such a view is not supported by today’s valuations. Short-term volatility in equity prices is likely to continue given world events as they stand today. This offers an opportunity as it creates fear among those investors with short-term investment horizons. The road will be rocky, and that won’t suit all investors, but for those with a long-term view and an eye for buying when others are panicking, the end result is more likely to be favourable.

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