With this Isa season almost certain to see a flurry of bond launches, current expectations of equity returns may be too much on the bearish side
Consumers on both sides of the Atlantic will play a very important part in what happens to markets over the next year ' just as they did over the course of 2001.
Spending in the shops over Christmas and through to the January sales has remained buoyant in the UK with just a slight sign of some easing off in America.
Last year's interest rate cuts ' eleven in the US and six in the UK ' were designed to keep consumers spending by cutting returns on savings and making borrowing cheaper. While is does seem to have worked, the question is whether consumers can keep going at this pace.
One of the big testing times will be during February/March when the Christmas credit card bills start dropping through people's letterboxes. If that prompts a tail-off in consumer spending in April/May time, we will be fighting hard to get even a subdued recovery this year.
We all know that the events of 11 September had a major impact on markets but economies around the world were suffering even before that. In fact, there are many people who believe we have just gone through the worst bear market since the early seventies.
In the UK, the economy has held up better than in many other countries, with the current Government continuing the prudent management of the economy put in place by the last administration. But that has not helped markets.
Over a period of 21 months, the FTSE dropped 36% and, despite a rally in the fourth quarter of last year, share prices are still 27% lower than at the end of 1999.
It has been a very poor period for equity investors and many have become cautious. This Isa season will certainly be a testing time ' I expect to see a flurry of new bond fund launches and the promotion of these as a safe home for investors' money.
There is much talk about the equity/gilt yield ratio and people are trying to cloud the choice between the two. Investors are often tempted into a market or sector at just the wrong moment and such will be the case, as far as I am concerned, if they fall for the bond promotions.
It is all the fashion at the moment to reduce people's expectations about growth from equities. Probably the current suggestions of 6% real return a year are too bearish but the point is that returns will remain positive and after a bear market, the time is right to look at equities.
That is the message advisers should be giving to their clients. In order to get above mundane returns, they will need to back a growth fund manager who has historically proved able to beat the market. Of course, fund managers will have a tough time but the key will be to find companies that will be able to drive profits even if the economy is slow to recover.
It will also be important not to get sucked into stocks at the wrong price. When the results of those companies with calendar year-ends start to filter through in February/March, share prices could end up under pressure, providing interesting buying opportunities.
When these results are largely out of the way, the market will be able to start to anticipate the recovery in the economy, which is expected for the third quarter of this year.
In 2001, it was defensive stocks that held up well but this year could be the turn of cyclicals and certain areas of manufacturing. I would look particularly for benefits in transport, support services, chemicals and some of the well-established industrials.
When you examine the FTSE Index, what you are actually looking at is a handful of giant companies predominantly in the oil, pharmaceutical, banking and telecom industries. As at the end of last November, the top 20 companies accounted for 58% of the stock market value and the top 10 for nearly 47%.
That shows just how important these industries are to index hugging funds but in my view they are the very industries that should be avoided in the coming year.
There have been moves of late to turn down the flow of oil and force prices up or at least to stabilise them at around $20 a barrel. But Russia is a fly in this ointment ' no one is sure whether it will play ball. In addition, price is a result of supply and demand. Right now demand is weak so it is going to be difficult to prop up the price. Oil companies may be growing but we cannot expect anything exciting from them.
Like other defensive sectors, pharmaceuticals have outperformed in the past year or so but sentiment is turning away. This industry is led by a handful of very large companies and their appetite for new products knows no bounds. Indeed, without a steady stream of these, it is difficult for them to maintain their growth and new products are not that easy to come by.
A lot of hopes and expectations have been thwarted by bad results from tests of new drugs in development or they have fallen down at the last hurdle ' failing to get Federal Drug Authority approval in the US.
That is where the earnings for these companies is vulnerable and while I would not suggest that growth will collapse, the rate of improvement will be sluggish at best. With pressure in the patent estate and prices, this is not an area in which I would want to be involved.
Much has been written about the telecoms sector and its problems are well documented. There is intense competition leading to pricing pressure and new competitors are still coming into the market so there is also over capacity. Balance sheets throughout the sector are overstretched and there is an urgent global need for re-capitalisation. That will mean equity and bond issues and the cross-holdings that many companies have are likely to be unwound. As a result, any signs of price recovery will be nipped in the bud and this is certainly a sector I believe should be avoided in the coming year.
Banks make up a huge UK sector, accounting for around 18% of the All-Share Index. Over the past year or so, they have benefited from falling interest rates but the question has to be how much further rates can possibly go.
Once interest rates start to climb again, the industry's over capacity will be laid bare. So far they have managed to hold margins but that is soon to come to an end. One of the perversities of the banking industry is that bad debts ' especially on the corporate side ' usually start to show up when the economy starts to recover from a slump. I therefore believe their scope to outperform is very limited even though they do not look particularly expensive.
If you take out these sectors you are then left with the fact that it is smaller to medium sized companies that will offer the best opportunities in the year ahead. With that in mind, advisers would do well to recommend funds with specialist knowledge in this area.
Even so there will be volatility ' it is a factor of the market that all investors now have to take into account. But the areas where there is potential for some companies to improve are those that normally benefit from an economic recovery, such as building, chemicals, industrials, engineers, transport, information technology and support services.
My own hope for the year ahead is to find those companies that have good management teams that can sparkle even in dull economic conditions. Signs of recovery will probably not be seen until the latter half of the year but it will pay to get in early.
Stockpicking, finding those companies that are undervalued and making sure that you are not too heavily linked to the index will be the keys to getting above-average returns this year.
Consumers on both sides of the Atlantic will play important part in what happens to markets over the next year.
The key outperformance will be to find companies that can drive profits even if the economy is slow to recover.
Medium to smaller companies will provide most opportunities in the coming year.
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