Expect further short term volatility but don't panic

While there may be further market volatility over the short term, equities are likely to outperform the money market over the next twelve months, says Mark Appleton, chief investment officer at Barnard Jacobs Mellet Private Client Services.

"Although the risk premium for equities has fallen below five percent, we believe that the bond yields will end the year lower, increasing the risk premium for equity investors," says Appleton.

Appleton explains that equity investors should expect a 5% return above the risk free rate, as indicated by the ten year bond yield, in order to justify the additional risk of investing in equities. Appleton says despite the tremendous bull-run over the last four years, that risk premium has remained above 5% until recently. However over the last few days, the bond yields have picked up and the risk premium has dropped to around 4.4%.

"We are therefore of the opinion that investors should remain cautious," says Appleton who believes that in the short term the markets could experience a further sell-off. "We have a situation where globally the bond yields have risen significantly," says Appleton who explains that this is in part a result of the Asian countries diverting surplus funds away from treasury bills. It would appear that this will continue to be the case given the intention by the Chinese to use surplus reserves to build up strategic stock piles of commodities and oil. "At the same time we have had worse than expected inflation numbers," says Appleton who says this has resulted in the long bond yield rising from 7.6% to 8.5%. In order to the risk premium to return to 5% the markets would need to come off a further 6-7%.

However Appleton says that bond yields are expected to fall again towards the end of the year and that overall equities remain attractive. Appleton says there are sectors like the banks which have been largely oversold and offer a buying opportunity, however there may be better buying opportunities in the short term. "We are following a cautious strategy and phasing in new money over a three month period".