The last few weeks we have seen that markets can change direction very quickly and it is difficult for investors to respond. As ever, the key is to maintain a well diversified portfolio which is frequently monitored and reviewed.
Equities
Following the aggressive rebound in stock markets last year, there is now something of a dichotomy surrounding stock markets’ valuations. Relative to history, valuations still appear cheap, with double digit earnings growth forecast for this year and next. However, companies’ profit growth has so far been driven largely by finite cost cutting and, going forward, to achieve consensus earnings would mean a nominal GDP growth of 6%; a figure we feel may be achievable this year, but one which is too optimistic for 2011.
It is naive to assume the ’old normal’ is alive and well in the post-crisis world, and we would argue that whilst shares are historically cheap, they deserve to be given what we see as several years of below trend growth. Valuations leave little room to manoeuvre and although momentum is clearly with the bulls for now, aided in no small part by a tentative recovery in the banking sector, investors would do well to remember that fundamentals do matter.
We have continued the theme of our previous asset allocation meetings, favouring the emerging markets over developed; where aging populations and significant levels of consumer and government debt will cap growth for years to come. We have also reduced some of our European exposure in favour of the US.
A byproduct of the stimulus packages that defined 2009 was an abandonment of fiscal and monetary discipline, a situation that governments and central banks will be keen to redress moving forward. The first tremors of these so-called ‘exit strategies’ was felt in Dubai some months ago, when the emirate, fearing its own solvency, declared it would no longer guarantee the debts of state-owned enterprises. Whilst Dubai was bailed out by Abu Dhabi, for the “PIIGS” (Portugal, Italy, Ireland, Greece and Spain) of Europe the situation is less clear. The recent bailout by the European Central Bank (ECB) and International Monetary Fund (IMF) means, at best, Europe faces a severe austerity programme lasting years; at worst, a fundamental crack could develop in the union.
Fixed Interest
A strong recovery in capital values during 2009 has seen the relative appeal of quality bonds to all but cash greatly diminished and, as such, we have reduced our allocation in favour of high yield bonds. Whilst high yield bonds do have a greater correlation to equities, we believe they offer better value than quality bonds and are now more secure following massive refinancing. As with other asset classes, our preference is to continue to diversify currency exposure away from sterling towards other currencies.
Other asset classes
Having turned positive on property last summer, we have seen portfolios benefit from a recovery in property prices, a situation we believe will continue at least into late 2010. However, as investors seeking income have been drawn in, the property sector has started to look more fully valued, with highest quality properties in particular attracting a multitude of both domestic and overseas bidders. As such, we are not inclined to add further to existing positions and will be marginally reducing our weighting to property. We continue to favour quality over the more speculative end of the property market.
Similarly, commodity prices have, overall, bounced back, stabilising at reasonably high levels. Given our cautious outlook for economic growth beyond the current round of inventory rebuilding, it is difficult to be optimistic for commodities in the near future, although we accept that longer term the demand for both hard (e.g. metals) and soft (e.g. wheat) commodities should support price appreciation. However, at current levels and with prices at the mercy of speculative investors, we are not inclined to add further exposure.
Whilst absolute return fund managers have struggled in what should be a stock picker’s environment, we remain positive towards the hedge fund sector. A variety of different strategies look set to come to the market in the second quarter of 2010, which will aid diversification within portfolios, and given the vulnerabilities surrounding both equity and fixed interest valuations, we are happy to increase our exposure to this asset class.
When we reconvene for our next asset allocation meeting, it will become clearer whether the economic recovery is showing signs of gaining genuine long term traction for the time being we remain cautious.
If you would like to discuss anything in regards to this article, please call one of our Investment Professionals on 020 7189 9999.