Super Isas are here - is it the worst time to buy?

Before you decide whether to invest in shares with your new Isa money, or how much to commit, how can you assess the likelihood of a sudden fall in the markets?

One approach is to examine the value represented by shares at their current prices. The most basic measure of the value of a market is its dividend yield.

Currently the FTSE 100 yields 3.4pc. A commonly used yardstick is that shares are cheap when government bonds (“gilts”) yield less. The 10-year gilt yield is 2.7pc, implying that shares are – if anything – undervalued, although sceptics say the gilt market is distorted by the official policies of low interest rates and quantitative easing or QE.

A related measure that focuses on company profits rather than dividends is the price to earnings, or p/e, ratio. For the FTSE 100 this stands at 14. The long-term average is about 15, again implying that shares are not overpriced.

The p/e ratio is sometimes refined by smoothing the earnings (profits) over the course of economic cycle, giving rise to the “cyclically adjusted p/e” or “Cape” ratio. The FTSE 100’s Cape ratio is currently 13.5, according to Cambria Investments’ most recent calculation, against a long-term average of 16. [See a map of the world's cheapest stock markets]

Other statistics give clues to the future direction of share prices. For example, the current bull market, which began in 2009 when shares stopped falling in the wake of the financial crisis, has so far lasted for 64 months. The average for postwar bull markets is 70 months.

But markets are not just about numbers. They are driven by sentiment too, which is harder to read. Stephanie Flanders (below), an economist at JP Morgan Asset Management, pointed out that there had been no serious interruptions to this bull market since 2011. “For that reason alone you might expect to get more noise in anticipation of an imminent correction,” she said.

But she added that anxiety over a possible correction in share prices was unsurprising, given how much further the markets had gone than the broader economy.

She has developed a “traffic lights” system to summarise the outlook for shares. There is one light each for valuations, economic outlook and political threats. Currently, the “valuation” light is at amber for caution but the other two are green. Accordingly, Ms Flanders is cautiously optimistic about the stock market’s prospects.

She said monetary policy around the world remained geared to boosting the economy by encouraging investors to take more risk by buying shares. Low interest rates also reduced the attractiveness of bonds and cash and helped companies by cutting borrowing costs. Meanwhile, inflation remained subdued but economic growth was getting stronger, she said.

All this is good news for corporate profits. Over the long term, the two key drivers of share prices are these profits and the attractiveness of other assets.

Charles Morris, who decides which assets are the best place for HSBC customers’ money, said he could see several indicators that urged caution, including a benign attitude to riskier bonds, more use of borrowed money to buy shares by American investors and a recent rise in the “Skew” index, which aims to track the likelihood of a sudden, sharp fall in the markets.

He added: “In my opinion a dollar rally will unsettle markets. This becomes increasingly likely as QE in the US eases.” But he still allocates a slightly higher than normal proportion of his investors’ money to shares.

David Hambidge, who runs “multi-manager” funds for Premier Asset Management, advised investors to focus on the income-generating benefits of shares. “The FTSE 100 has yet to recapture its high of 6950 of December 1999,” he said.

“This in its own right is no reason to invest. But with Britain’s top 100 quoted companies yielding on average around 3.5pc, investors are likely to be rewarded with a cash-beating total return in the medium term and a cash-beating income over the short term.”

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