Cheap but not cheerful

London - After a rollercoaster week in risk-averse markets, world stocks are looking decidedly cheap -- but can that convince investors to pile back in?

Valuations have fallen steeply as the benchmark MSCI world equity index has hit 11-month lows , losing 15% in less than a fortnight. The index has slipped into a bear market territory by dropping more than 20% from its three-year high in May.

According to Reuters data, the 12-month forward equity earnings yield stands at just over 10% for the MSCI index, its highest since January 2009 and more than five times the yield on 10-year US Treasuries .

But even such attractive valuations may offer little comfort in the midst of turmoil. After a relief rally at the back end of the week, investors mindful of the US economic slowdown and a creaking euro zone banking system are braced for a further sell-off.

"When ... fear grips the market, valuation is never a timing tool. Valuations are very helpful in understanding the downside and potential upside. They don't help you in deciding whether markets have capitulated," said Rupert Howard, head of UK Portfolio Management and Rothschild Wealth Management & Trust.

"We're at the whim of policymakers, that's always a dangerous place to be. Cheap markets can get cheaper if you make wrong decisions at the top of the tree. Volatility is at its extreme. It does make decision-making very difficult and sometimes doing nothing is by far the best strategy."

Investors pulled a net $14.4bn out of US-domiciled equity funds in the week ended August 10, the biggest wave of net redemptions since May 2010, according to Reuters Lipper data.

With more than 10 developed stock markets - including Britain and Germany - now boasting 12-month forward price to earnings ratio of less than 10%, some players do see value.

Blackrock said on Tuesday it will use profits from gold and bond markets to seek out bargains in falling global equity markets .

Investors are also particularly sensitive to any sign of funding stress in the money market, one of the first sectors to deteriorate at the onset of the credit crisis in 2007.

Over the past week the interbank market have showed signs of stress, although the magnitude was smaller than dislocations seen at the height of the credit crisis.

In the FX swaps market, the premium for swapping yen LIBOR into dollar LIBOR over one year - known as the cross currency basis - hit 55 basis points on Friday, the widest since the 2008 financial crisis and 13 bps wider on the week.

Traders have said that European banks have access to dollar borrowings in short-term tenors of one night up to a week, but after that point other banks are getting more selective about who they lend to.

That has prompted the European banks needing funds to turn to FX forwards and swaps for their needs, causing a sharp widening of the dollar premium in FX swaps - especially in the euro and yen markets.

Some European regulators responded to the unease by banning short sales of financial stocks, calming share markets on Friday .

Jeremy Grantham, chief investment officer at US money manager GMO, remains focused on quality stocks that offer steady returns.

"I would continue to overweight quality stocks... They are not priced to make a fortune, but they are priced to give approximately 4-5% real return," Grantham said in a note to clients.

"As for the rest of global equities, they range from unattractive to very attractive. The S&P 500, for example, is worth no more than 950 on our estimates."

That corresponds to a 19% decline on the index from Friday's level. "In general, risk avoidance looks like a good idea," he said.