Lilley, manager of the Old Mutual European Equity (ex UK) fund, understands why some investors are nervous of rising markets given the turbulence experienced since 2000; however, he believes we could be returning to a time when all-time highs are a regular thing.
“Market commentators are fixated on the term 'bubble', using it to describe equity indices hitting new highs,” he explained.
“I would argue that equity markets reaching new highs is a fairly normal event. It is the last 13 years that has not been normal, with markets remaining below peak due to the extreme overvaluation at the beginning of the millennium, the height of the dot-com boom.”
Performance of indices over 13yrs
Source: FE Analytics
Lilley says nervous investors are forever looking for worse case scenarios, which distract them from fundamentals.
“Instead of obsessing on the unpredictable, investors should look to the positive environment they see in front of them. In 1970 Marc Bolan wrote the lyrics to 'Ride a White Swan', the song that would become the first hit for his glam rock band, T. Rex. It might be pertinent to today’s equity markets,” he added.
“Today, we live in an environment where investors are constantly looking for ‘black swans’, the name famously given by Nassim Nicholas Taleb to events that could not possibly have been foreseen. But such events are by definition extremely rare.”
“It is normal to be in a white swan environment and, while not ignoring the risk of setback, this is surely the path for which we should plan.”
Looking at the path of the MSCI World index since 1969, it’s clear that the years preceding 2000 were a very good time to be an equity investor.
Performance of index since 1969
Source: FE Analytics
Lilley claims it’s the last 13 years that have been the exception, saying that certain areas – namely Europe – are at compelling entry points even though some regions have had a strong five years or so.
“If markets traded on a constant fair multiple of profits or cash-flow, the norm would be for new market highs more often than not,” the manager continued. “Profits and cash-flows will normally follow the direction of nominal economic growth, which incidentally has risen in most of the past 13 years.”
“Due to the specific impact of the successive eurozone crises since 2010, there appears to be substantial potential for European equities to catch up with other equity markets. Not only is the European economy emerging from recession, the impact of self-imposed austerity measures is diminishing, removing a significant economic drag.”
Performance of indices since Jan 2010
Source: FE Analytics
Lilley explains that unlike their global peers, European company profits and stock markets remain well below peak. With attractive valuations, a recovering economy, a return of international investors and an unlimited European Central Bank (ECB) backstop in place, Europe would appear to have significant potential for 2014, he says.
“We don’t expect plain sailing, but in my experience of over 20 years, this has never been the case, even in the big up years,” he said.
“The threat of a eurozone breakup now seems unlikely, apart from in the eyes of the loudest Europhobes, and the euro has returned to trend versus the US dollar,” Lilley said.
“Political resolve remains strong, as the alternative of a fragmented Europe would mean a significantly reduced influence in global political affairs, encompassing both trade and security and defence issues, particularly as the Chinese and other faster growing economies demand more influence.”
“With market multiples of current year profits not looking stretched, and nominal economic growth forecast to rise over the next two years at least, surely we should be embracing these markets and 'riding the white swan', anticipating returns at least in line with profit growth plus dividends?
Lilley has run the Old Mutual European Equity (ex UK) fund since December 2011, and its offshore equivalent since April 2013.
The onshore fund has marginally outperformed its sector and benchmark since the manager took over, with returns of 57.36 per cent.
Performance of fund, sector and index since Dec 2011
Source: FE Analytics
He is the former manager of the Royal London European Growth fund, which he ran for a decade between 2001 and 2011.