Rocky road ahead for equities in 2012

Equities are still attractive on a valuations basis, but volatile market conditions are likely to test the nerve of value investors in 2012, according to van Eyk head of research John O'Brien.

Just as in 2011, markets are underestimating the downside risks at the moment - and uncertainty caused by political and economic turmoil will act as an impediment to an upswing in equity markets in 2012, according to O'Brien.

But despite that, equity valuations "are not outstandingly good, but they're not bad" according to O'Brien. The ASX 200 is trading on 11 times forward earnings, the MSCI World index is on 12 times forward earnings and the MSCI Emerging Markets index is on 9.5 forward earnings, he said.

In the short term, political risk and a potential outbreak in inflation could cause investors headaches, he said.

"We still believe that political risk as it affects market returns is underrated as we did in 2011. Iran, the Arab world, Latin America, even stable countries like Thailand could all have problems this year," O'Brien said.

But the disillusionment of many investors in shares could be a signal to bullish investors that equities have turned a corner, he added.

O'Brien pointed to the wide gap between the benchmark US Treasury bond yield of less than 2 per cent and the equity earnings yield of 8 per cent.

"We can certainly say that piling into low-yielding assets, like bonds, at ever-higher prices isn't a long-term solution," O'Brien said.