A new year, a brave new world
Market views
The main impacts of a tumultuous 2008 will be felt throughout 2009.
Consumers and businesses are building savings as a precaution in these uncertain times. Global growth has fallen off a cliff as a result
and, because the deleveraging process will take some years, the negative impact on the economies will take time to erode. Investors
have sold down assets with geared balance sheets like banks, property vehicles and hedge funds. In turn, they have become forced sellers of
their assets. Bestinvest’s Chief Investment Officer, GRAHAM FROST, looks at the main sectors below and suggests possible vehicles.
EQUITIES
Valuations are at generational lows so unless this recession is as bad as the 1930s (and even then there were big
rallies in the downtrend) they appear to offer good value on any reasonable time horizon. Rating multiples generally rise in a falling interest rate
environment and, despite a poor earnings outlook, recessions have often proved the best time to invest and can generate substantial returns. You would, however, need to see credit
markets performing better for any recovery to be sustainable. The US was first into the downturn and has taken the most aggressive action, so is likely
to be first out when compared with the UK and Europe. Much is in the relative price already. On a multi-year view, higher growth and better
demographics in Emerging and Asian markets are likely to provide better opportunities for investors than developed markets which will all be in
recession in 2009, and they are also trading on low multiples. Our preferred recommendation for Asia is First State Asia Pacific Leaders.
BONDS
Gilts
Government bonds have discounted a deflationary outlook. Raw material prices have halved since last June and
VAT has been reduced. So, whilst there is likely to be a period of negative inflation, these developments actually
leave more money in consumers’ pockets. Unemployment will continue to rise and that encourages consumers to
save rather than spend. A year out, however, those year-on-year effects move out of the calculation and with
weak sterling, deflation is unlikely to become entrenched. Furthermore, the Government is issuing massive amounts
of paper so there will be upward pressure on rates in the gilt market.
Investment grade
Investment grade corporate bonds on
the other hand, although facing similar
rising supply, are forecasting default
rates worse than the Great Depression.
Since they get paid interest before
equity holders get paid dividends, and
get paid any residual interest before
equity holders in the event of
liquidation, this asset class appears to
offer good value on a risk-reward basis.
High yield
Defaults are going to accelerate rapidly
now and, due to the large issuance of
poorer quality paper in recent years,
it’s too soon to buy high yield paper
except on a very selective basis.
Our top recommendation in the bond
sector is Fidelity Moneybuilder Income Fund.
CASH
Falling interest rates make this asset
one to avoid for all but the least
adventurous investors. Interest rates
are already at 1.5% in the UK and
likely to go lower. Banks, still keen
to get short-term funding, are offering
commensurate rates so investors
should search around for the best
fixed-term rates from banks that are
backed by Government guarantee.
PROPERTY
Property is still on a downward path
driven by forced sellers in danger of
breaching loan covenants. Due to its
illiquid nature, it may be last to
recover, but there are opportunities in
shares of listed property companies
trading on large discounts to assets.
Infrastructure investments should also
benefit from increased Government
spending to stimulate the economy.
COMMODITIES
Precious metals have been mixed.
Gold has been one of the most resilient
commodities, its traditional qualities as
a store of value seem to be growing
more popular. Platinum (which is also
used extensively in manufacturing) has
been very weak. Mining shares have
been hammered and potentially now
offer good value although they face
specific risks (e.g. power outages in
South Africa).
Industrial metals have collapsed in
price following the big slowdown in
exports from China and with forecasts
for growth still being lowered the
outlook appears poor. However, mines
are closing as prices are well below the
marginal cost of production and the
massive fiscal stimulus should stabilise
industrial production during 2009 so
this is a potential area for a rebound.
Energy, notably oil, has been
extraordinarily volatile. The debate
over whether Peak Oil has been
reached continues to ebb and flow but
it is only a matter of time before supply
reaches a plateau and then declines.
Therefore we remain bullish in the
medium and longer term.
Soft commodities have also been weak
even though demand is largely
uncorrelated with economic activity.
This reflects the deleveraging of hedge
funds leading to an unwinding of
positions. However, long term supply
constraints seem likely to intensify and
this is a sector with considerable
medium term potential.
Our preferred vehicle for participating
in this asset class at present is
Blackrock Gold & General which
mainly invests in producers. Clients
who prefer to gain access directly to
baskets of commodities should consider
some of the Exchange Traded Funds
now available though they should be
aware of the impact of the costs of
renewing the futures contracts every
three months in these vehicles.
Structured products are also an
attractive way of participating while
protecting the downside risk.
ALTERNATIVES
Hedge funds are in the midst of a
shake-out and half of the funds in
existence are susceptible to closure.
The survivors, who can operate without
gearing, will enjoy opportunities to
improve returns. Selective buying
should prove rewarding and some
quality managers are available on
large discounts to assets.
Private equity is likely to remain
under the cosh due to high levels of
gearing and/or high cash burn rates.
Private equity will have to get back to
running businesses rather than taking
a quick return. Again, large discounts
to assets incorporate a lot of bad news.
It may be too soon to invest except on a
selective basis.
Our top recommendation in the
alternatives arena is Brevan Howard
Global Macro investment company.
Despite the very poor economic outlook, opportunities are presenting themselves.
Investment grade corporate bond funds are offering good risk return characteristics
compared to other assets and should be over-weighted. Forced selling is creating
opportunities for longer-term investors in the hedge fund, commodity and property sectors.
Although diversification did not provide much benefit in 2008 due to the all-encompassing
nature of the credit crunch, we believe that when credit conditions return to more normal
levels, and forced selling ends, diversification will once again benefit investors and it
remains a prudent strategy.
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