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May 29, 2009 6:36 pm
The rising tide pushing up cyclical stocks is encouraging the view that the market has touched bottom and the world’s economy is improving.
But investment managers say it is difficult to forecast how long the upswing will last and when and where the peaks and troughs will come.
More sceptical observers claim markets are likely to remain choppy all summer, and valuations will fall as companies face difficulty gaining credit, rising unemployment takes its toll and companies and fund managers hoard cash.
“My thesis is that the recession is shaped like a ‘W’ but it has many legs and, though we are experiencing a rise, valuations may well continue to be dragged down by different forces,” says Virginie Maisonneuve, head of global equities at Schroders.
Others are more bullish. “We firmly believe that this has been the start of a new bull market and do not see a significant correction happening until higher levels are reached,” states Max King, strategist with Investec Asset Management.
The pace of negative economic reports from both the US and the UK has slowed and demand from investors for riskier equity funds – particularly those invested in large emerging markets such as Brazil, Russia, India and China – is rising, optimists point out. The surge in new equity issues is also improving the strength of companies’ balance sheets and the fall-off in corporate bond spreads and interbank lending rates suggest credit conditions are easing.
Recent results in sectors such as UK small-caps and property also look promising. Last month, Close Special Situations fund was up 32 per cent, SWIP’s UK Real Estate fund gained 30 per cent and Schroder’s Recovery fund rose 25.5 per cent, according to Hargreaves Lansdown, the advisory firm.
But further market downturns are likely if economic growth shrinks in the coming months as expected. The UK’s gross domestic product is expected to contract by 3.5 per cent, Germany’s by 5 per cent and the US’s by 3 per cent – hitting companies’ earnings and keeping a lid on rising markets in the short-term.
And fund-raisings by companies are not always effective. This week, Wolseley, the UK plumbing and building materials group, revealed it has cut 3,500 more jobs to slash costs further – even after its £1bn cash call in March.
“It’s quite possible that the market could lose 10 per cent, but it would then, I believe, offer a good buying opportunity,” predicts Tim Cockerill, head of research with Rowan, the advisory firm. “What’s encouraging about the recent rally is that it is broadly-based and is characterised by a slower ascent with less volatility than previous bounces.”
The consensus among advisers is that if the recovery gathers pace, more investors will look to join the migration towards cyclicals which are more dependent on the economic cycle for profits. Cyclical sectors include industrials, banks, insurance and property groups.
As it stands, the market “has been moving sideways”, with defensive stocks such as food, tobacco, pharmaceuticals and utilities – as well as government bonds – now being replaced by cyclicals in many fund portfolios. “There is greater belief that the market will continue to do this over the coming months with some clawback of the gains made since March,” points out Adrian Lowcock, senior investment adviser with Bestinvest.
Proof of this is already evident on the institutional side as a number of managers of large funds have altered their portfolios’ asset allocation quite radically. When the markets hit a low last year, Baring Dynamic Asset allocation fund had just 15 per cent in equities. Now, about 53 per cent of its portfolio is in equities, with 30 per cent in bonds, 5 per cent in cash and the remainder in other assets such as gold.
In the past two months, shares in banks, insurers, industrials and property companies have risen while the performance of tobacco, utilities and pharmaceuticals has been muted.
UK bank shares are up 38 per cent since the end of May and life insurers have gained 32 per cent. Tobacco groups, meanwhile, have reported a return of just 10 per cent and utilities are up 13 per cent.
But no one sector is markedly ahead of the pack in the short term in terms of valuation, argues Cockerill of Rowan. And some managers are still buying into defensives, with cash-rich pharmaceutical companies looking attractive. GlaxoSmithKline trades at 10 times forward earnings while AstraZeneca trades at eight times next year’s earnings, for example. Fertiliser makers, selective telecom stocks offering higher yields and gambling groups and silver also look interesting, says Jonathan Compton, managing director at Bedlam Asset Management.
In addition, rising UK and US government debt is prompting a number of financial advisers to look to China and other parts of south-east Asia as promising markets for investment.
“These areas have a robust banking system and a young population which should help generate domestic demand to fuel this next phase of growth,” claims Lowcock of Bestinvest. “And commodities will continue to play an important role.”
Investec’s King forecasts that the US, Asian and emerging economies are past the worst, while Europe and Japan will touch their lowest points within six months and the UK by early next year. “That timescale remains on track but, after an initial bounceback, the upturn is likely to be held back by an aversion to debt, by consumers rebuilding savings and by government retrenchment,” he cautions.
Rising stock markets are also helpful to those hunting for income. While dividends have been cut sharply amid the financial crisis (Marks and Spencer for example, announced it would cut its dividend for the first time in nine years), a number of defensive stocks trading at low valuations offer enticing yields.
National Grid, the utility group, pays 5.7 per cent and is looking to grow its dividend payments by at least 8 per cent this year; BP offers 7.5 per cent; GlaxoSmithKline offers 5.2 per cent; and Vodafone, which reported strong results for the year, 6.5 per cent.
“The past year has been one of turmoil for investors seeking income, but there are still some great opportunities,” says Nick Raynor, investment adviser with The Share Centre, the UK brokerage group. “Investors should be looking out for companies that are traditionally defensive, coupled with an ability to expand globally.”
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