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Evidence of recovery needed to support equities, says Legal & General

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Although the rise in equity markets to date is justified, market participants will need to see evidence that economic growth can be sustained in order to achieve significant upside from here, according to Legal & General Investment Management’s equity strategist Georgina Taylor.

Taylor (pictured) says the outlook for key economic indicators remains incredibly important in the near term.

Equities have rallied from extreme lows on the back of extraordinary liquidity and hope surrounding the economic recovery.

During the crisis, L&G has identified four key factors which have helped drive the performance of equities: government policy, economic growth, inflation and valuations.

Back in May, all these factors supported a continued rise in equity prices. Today, however, there is significant uncertainty surrounding how much longer governments can maintain such accommodative policy measures.

In addition, the unprecedented amounts of liquidity which have been pumped into the financial system via quantitative easing and low interest rates have not necessarily found their way into the right areas of the economy as yet. While the monetary base has expanded aggressively, bank lending remains constrained, says Taylor.

The bright spot for equity investors, however, comes in the shape of dividends. Since the end of 2008 the level of dividends for the UK market has fallen 20 per cent and the yield is now in line with its long term average of 3.5 per cent.

At this level, dividends are far more sustainable than at this time last year and this implies that focusing on quality dividend paying companies presents an investment opportunity as we move into 2010, says Taylor.

On a relative basis this gives support to the higher dividend yield markets globally which are Europe and the UK over Japan and the US.

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