When Swiss bank UBS stuck its neck out in the last quarter of 2003 to declare the Bear market was officially over, more than a few sniggers were heard around the City.
Still, it was hard to argue with the numbers: the bank’s quarterly results reported at the time noted earnings per share were up a whopping 66% compared to the same period last year, helped by greater flows of money into its funds from both institutional and retail clients.
Since then the big four UK clearing banks have reported their own rosy results, also indicating just how good a year it was.
The London stock market had one of its best performing years ever in 2003, however this is not too surprising given trading has been through its worst Bear run since the Depression. However, questions have been raised as to how well the market can sustain gains made since the March 11, 2003 low. Particularly as the FTSE All Share index has risen 40% since then.
Richard Martin, chief executive of multi-manager provider T.Bailey says he see two main investment themes developing this year: big cap vs. small and mid-cap, and asset allocation between geographical regions.
“The themes last March were that you had to be in poorly and undervalued stocks, and then mostly in small and mid-caps,” he says.
“You also had to be in the US, UK, Europe and a bit in Japan. A lot of the small and mid-caps potential is played out for the moment - although we still like mid-caps because it enables managers to prove they can provide good alpha,” continues Martin.
“Now, however, interest is swinging back towards the big caps and income, so we’ve already taken the top off some of our holdings and put the money elsewhere, such as the Gartmore UK focus fund.”
Tom Elliott, strategist at JPMorgan Fleming, says he expects his focus on the UK equities sector to be targeted at big caps and cyclical stocks. The latter are geared to benefit from the recovering global economy and attract money which last year went into smaller and mid-caps stocks.
That said, Elliott sees one fly in the ointment: UK blue chip indices are still dominated by oil, pharmaceutical and banking stocks which means European markets may outperform UK equities investment this year because indices on the Continent are more exposed to cyclicals.
Andreas Lehmann, managing director of J O Hambro, says his house is turning bullish on Vodafone and the capital goods sector as “…the recovery is spilling over into capital expenditure”.
While mid-cap stocks appear to have fallen out of favour with many fund management houses, it so far looks like some stocks still have potential for gains. Pilkington, for example, it makes glass for windshields and buildings, is benefiting from record sales of new cars in the US, China, and many European markets. US new home starts in December hit levels not seen since the early 1980s, which should also increase profit potential for Pilkington and plumbing supplies firm Wolseley.
Conventional wisdom would say the US is easily going to outperform all other stock markets over the next 12 months because government spending taps will be turned on as far as possible in an election year. History also tends to suggest the third year of a presidency usually coincides with a bounce, which has certainly been the case so far.
However, there are also warning signs that the growth in US stock values has peaked, at least for the time being.
Alan Torry, SG Asset Management US Growth fund manager, says fears of a jobless recovery - expressed early in the last quarter of 2003 - have dissipated somewhat and improving manufacturing data points to a “strong” economic recovery.
SG took some cash out of its US positions in December, before again returning. The fourth quarter US growth rate was well moderated at more than 8% on an annualised basis, and this rate is nonetheless easily sufficient to keep the US recovery on track.
Torry certainly believes it is hard to see US GDP growth of less than 4% through 2004.
Dollar weakness against sterling and the euro is one factor which could soon swing the equity markets again, as the dollar is “nearing the turning point,” Torry says. And while a weak dollar is seen as a problem for UK investors - because it reduces their returns they gain in the US once exchanged back into sterling – the US markets will feel some benefits of a weaker currency, as firms will experience gains in fundamentals.
In this respect, “the economy is going to do for Bush what it failed to do for his father,” suggests Torry.
Other firms to reduce their exposure to US equities include Insight Investment. It suggests the “dollar issue” will lead to falling capital flows to that market, increasing sales of shares by directors in US listed companies, and weakening market momentum.
JPMF’s Elliott says US price/earnings values at the beginning of January are “rich”, encouraging the view that investors should go underweight.
T.Bailey’s Martin says he has been underweight US stocks for a long time, so performance over the past year “vindicated” that decision. He points out the UK stock market beat the S&P 500 index, and European equities markets beat UK performance. In particular, Martin says he is increasingly concerned about the dollar - which could slip yet further in value - as there is further added pressure to keep interest rates low given it is an election year, when interest rates might actually need to go up sooner than some people expect.
State of the US pensions markets is another problem which is not so much talked about in relation to US investments, adds Martin, however, current fund performance may hurt market trading. The pension funding crisis in the US could be worse than currently thought because of the flexibility accorded corporations to account for their pension liabilities. This could be one reason why so many companies went into Chapter 11 bankruptcy protection in the past year, Martin says.
Pensions are very much on the mind of European investors, not least because of the politically painful tax changes being wrought in Germany and France to limit state pension liabilities. That said, the positive flip side is inflexibility in labour markets and fiscal policies is being undone.
Cambridge Econometrics has identified inflexibility, and the Stability and Growth Pact in particular, as chief causes of the eurozone’s inability to generate faster growth. European businesses have suffered from a monetary policy that has left interest rates at levels twice that of the US. The euro has appreciated way too far – according to some investment analysts - and the Continent is now suffering its own Enron scandal in the form of Italian food group giant Parmalat.
However, Europe has managed to maintain its position as the headquarters for some of the world’s best-performing stocks, while some markets such as Irish corporate sector look set to outperform for another year. Gervais Williams, manager of Gartmore’s UK & Irish smaller companies fund, remains positive about prospects. The Irish government, which took over the rotating presidency of the EU on 1 January, says more needs to be done to enable businesses to make profits.
Even large-cap selections have managed to reward stockpickers. Nokia surprised everybody with a trading update on 8 January revealing the firm had upgraded its own forecasts for sales of capital equipment needed to operate next generation mobile phone networks. Unilever was also upgraded to a ‘buy’ recommendation by analysts at Deutsche Bank on the same day.
Japan & Far East
Many of the most bullish statements concerning investment this year are so far reserved for Asia, where China in particular seems to have unstoppable potential. The effects of this growth are being felt as far away as Latin America, where a trade surplus is expected this year because of the flow of commodity imports to China, such as copper from Chile.
With high demand comes high prices, however, as analysts at Cazenove said in a recent note - on JPMorgan Fleming’s China investment trust - it may be better to play China by proxy. They suggested funds focused on metals and mining may be the best investment options. Chinese imports of raw materials are forecast to continue increasing in line with its growth in exports, which Cazenove says will go up by another 25% this year.
Hong Kong, as a proxy for China, is once again seeing big flows of money into its stock market. Demand for shares in China Life - the biggest life insurer in the PRC – have soared through the roof in Hong Kong, leading a quarter of the population to apply for shares in the recent $3bn public offering.
Japan is another proxy, with a twist. Following more than 10 years of economic decline, Japan is now, finally, thought to have turned the corner in terms of the state of its domestic economy. Continued economic reforms coupled with record profits being reported by stalwarts such as Toyota, is encouraging J O Hambro to launch a retail Japan OEIC this year. “There are interesting opportunities in small- and medium-sized firms there,” says managing director Andreas Lehmann.
Insight Investment also suggests Asian stocks have an edge over European rivals because growth prospects, valuations are all better placed, as are Asian currencies against the dollar compared to the euro.
Emerging Markets/ Eastern Europe
The first Eastern European members of the EU will join this year, with more to follow. This should see asset managers start to make investment plays based on the firmer rule of law, including stronger financial regulatory regimes, that these new member states must adopt as the price of joining. Turkey will not join for some time, but a potential EU member with a population equal to the current largest member Germany, it remains a key high-risk investment selection.
Investment potential in Africa still has to perform better than the South African market to look attractive. Firms there have benefited from currency swings and rising demand for metals and energy in the form of coal exports, all of which are priced in dollars. Gold prices have soared to new record highs – and record lows – in recent months, increasing profits for miners. The question now is whether the price will fall further.
Russia should also find its prospects improve, bearing in mind politics could still play their part in altering investor interest. The arrest and detention last year of the chief executive of Yukos Oil caused brief panic in the stock market, but with the case seemingly isolated, confidence has returned. The country continues to benefit from high oil prices and demand for specialist metals such as nickel, of which Russia is often one of a few or even the only exporter.
Bond markets saw a rush of investor interest in 2002 and early 2003, as the value of equities plunged further. Times have changed, however, with interest rate cycles around the world ticking up along with company profits.
With equity markets improving, Insight Investment is now neutral towards bonds, suggesting bonds are still fairly priced, although it expects short-term interest rates to rise less than prices being quoted in the market. Insight says the UK will lead the cycle of interest rate increases, raising the base rate in the first quarter, with the US following suit in the second quarter, and the first eurozone increase taking place by the third quarter.IFAonline
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