Turning panic into opportunity

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as you do now.

Another measure that could make shares attractive is a single-digit price/earnings ratio. Higher inflation tends to drive down p/es, because it leads to more volatile economic conditions. Investors may also be worried that profits are high, relative to GDP, and are thus due for a fall.

But single-digit p/es would compensate investors for those risks. Flip the ratio around and you have the earnings yield, the percentage of the share price that is represented by profits. If the p/e is in single digits, the earnings yield is above 10%. On the latest data, a number of European markets, including Belgium, France, Ireland, Italy, the Netherlands, Spain and Sweden fall into this category; with the DAX on a p/e of 10.6, Germany is not that far away. (Wall Street, by contrast, has still a fair amount to fall on this measure.)

On valuation grounds, therefore, investors should at least be thinking about opening their wallets. Of course, valuation is not the only factor that drives markets, as became clear during the dotcom bubble. Just as prices can be driven far above fair value in periods of euphoria, so they can be driven far below it in periods of fear.

And sentiment is pretty depressed. The Merrill Lynch survey of global fund managers, released on July 16th, found that a record number were overweight in their holdings of cash and underweight in shares, and most thought that profit forecasts were far too high. That poll suggests investors are already braced for a good deal of bad news.

What is needed to get markets out of their funk is a catalyst. It would help if the uncertainty cleared. In both 1991 and 2003, markets rallied as wars against Iraq began. That was not because the wars were good news, but because investors had been made so uncertain by the pre-war tensions.