Stock markets gave a muted reaction to Barack Obama’s election win and a huge cut in British interest rates last week — but some experts say now is the time to buy.

Brokers had been expecting equity indexes on both sides of the Atlantic to rally sharply after the election, but in the event the S&P 500 soared 4.1% the day before only to fall 5.3% after the result was announced — a classic case of rising on the expectation and falling on the news.

The size of the Bank of England’s rate cut surprised analysts — most had expected a half-point cut — but it failed to boost the stock market, with the FTSE 100 index falling 5.7% on Thursday. It closed the week down 12 points at 4,365.

The cut in Bank rate came after the release of figures showing that Britain’s service sector, 55% of national income, was declining sharply. The jobs market was at its weakest since 1997, and factory output had contracted at a record pace for the longest period since the 1980 recession.

“The market’s reaction was somewhat mixed,” said Julian Chillingworth at Rathbone Unit Trust Management. “There’s a sense of ‘do they know something we don’t?’, and that things must be really bad. There is also a sense that the Bank has been behind the curve, in which case is this a gesture too late?”

At the start of last week, though, Teun Draaisma at the investment bank Morgan Stanley, one of the City’s best forecasters, said it was time to get back into equities.

So, should investors prepare for an end-of-year rally? We look at the evidence.

Key indicators

Morgan Stanley said its market-timing indicators started flashing a “full-house buy signal” on October 31, an about-turn from its “full-house sell signal” in June last year.

Each of four indicators — valuations, capitulation, risk and fundamentals — is now pointing to “buy”.

Draaisma said retail investors, purchasing managers and analysts had retreated — the capitulation indicator. Retail investors took a net £529m out of funds in September, according to figures last week from the Investment Management Association. In the same month last year they put in a net £2.6 billion.

Very weak manufacturing data and “collapsing” analysts’ earnings forecasts also suggest that equity markets are pricing in enough bad news, Morgan Stanley said.

The bank’s indicators are not always spot-on: for example, they did not flash “sell” ahead of the steep plunge in stock markets over the past two months.

However, the bank said its model tends to work 80%-90% of the time, and had pointed to getting out of equities ahead of falling stock markets in 1987, 1990, 1992 and 2002. “The bad news is now in the price, and we don’t wish to be short on equities,” said Draaisma. “The severe part of the bear market is over.”

Seasonality

Stock markets tend to do well between November and April.

Had you invested £100 in the FTSE All-Share in 1962, it would now be worth £2,183.69. The same amount invested only in the months May to October would be worth far less — a miserable £45.36.

Had you invested from November to April each year, though, you would have £4,814.17 — over 100 times more — Rathbones said (see graphic).

Long-term moving average

One of the simplest ways of deducing how oversold the market is, is to work out the deviation from the long-term moving average.

The MSCI World index is 32% below its 40-week moving average — it has been more oversold in the past month than at any time since it started in 1970.

However, Darius McDermott at the adviser Chelsea Financial Services said: “One of the strongest indicators of a long-term buy is what’s known as a ‘golden cross’, dictated by a crossover of the 50-day moving average above the 200-day moving average — and we’ve not got this yet.”

Election boost

Historically, the US stock market has usually risen after a presidential election — particularly when the victor is a Democrat. The S&P 500 has gained, on average, nearly 7% in the three months after a Democrat victory, and nearly 14% in the following 12 months. After a Republican win, the market has risen 11% in the subsequent year.

Marc Pado, market strategist at Cantor Fitzgerald in San Francisco, said: “After an election that really ran on change, there’s going to be optimism now. There’s going to be a refocus on higher days.”

However, the best returns might be some way off: looking back to 1926, markets have rallied the most in the third year of a four-year presidential term.

A post-election bounce might be a near certainty in other circumstances, but today economic woes take centre-stage. Gary Marshall of Aberdeen Unit Trust Managers, believes markets will remain volatile for at least the next six months. Collins Stewart has urged investors to reduce their exposure to equities: “The rush for the exit could become awfully crowded,” said director Alan Brierley.

Risk and reward

Some 48% of British investors say they are taking less risk with their investments since the onset of the credit crunch, even though a third believe shares and property continue to yield the best long-term returns, said Axa.

However, Gary Dugan, chief investment officer at Merrill Lynch, said investors need not take “incredible” risks to get “potentially good returns”.

“All markets — high risk and low risk — have had massive falls, and investors need only take modest risk to make double-digit returns,” he said.

Pound cost averaging

Drip-feeding money into the market will help to reduce your risk — and is particularly effective in a downturn. Say, for example, you invested £1,000 in the FTSE All-Share mid-way through the stock-market falls of 1972-74 and 2000-3 — in August 1973 and July 2001. Five years later, you would have had an investment worth £1,308 and £1,128 respectively, excluding dividends, said the fund manager Black Rock.

However, if you had invested the same sum gradually over the five years, you would have £1,607 and £1,302 respectively.

“Buying through the downturn can pay off handsomely in the medium and long term,” said Alex Hoctor-Duncan at Black Rock.

And Draaisma urges investors to “keep on averaging in at these and lower levels”.

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