2013 may be a good year for global equities

EQUITIES can be driven higher by earnings growth or by expansions in the multiple - an increase in the price-earnings ratio or multiple of a stock or group of stocks.

While there is limited prospect in 2013 that earnings growth will supply a strong catalyst to equities, there is a strong chance that equities will be re-rated in 2013 and there are three reasons for this.

The first is that equity valuations are reasonable relative to history with price-earnings ratios of around 13-14 times the trailing 12-month earnings.

While this is not extremely low, the relative allure of equities is enhanced when valuations are compared with the low yields on sovereign and investment-grade bonds.

The second case for stocks is tied to the sustained sell-off of equities in recent years, so much so that institutional levels of equity ownership are now at 30-year lows.

Equities are an unloved asset class and there is growing scope for this trend to reverse, especially now that people are talking of a bond bubble.

The third favourable trend for equities is that volatility has subsided. Since 2008, the Chicago Board Options Exchange Volatility Index (VIX), a key measure of market expectations of volatility, has often spiked above 20%.

Encouragingly, the VIX has fallen back to around 15% and has held below 20% since July.

While these factors make re-rating possible, there are hurdles to be overcome, including the lack of a resolution to the US fiscal cliff, the banking crisis in Europe remains unresolved and events in the Middle East could jolt investors.

As government bonds are failing to provide a store of value after inflation, investors will search for yield. Income remains an attractive option, given how yields on equities compare well against those offered by government bonds.

Around the world, balance sheets are healthy, cash flow is solid and pay-out ratios are low with scope to grow.

We could see earnings of 4-5% in 2013, particularly from large high-quality companies.

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