I'd like to try to persuade you to break one of the oldest sayings in the investment business: sell ...
I'd like to try to persuade you to break one of the oldest sayings in the investment business: sell in May and go away. To convince you to go against that idea, I will need to explain three things: why the market is where it is, why it is right to invest now and how I believe it is possible to invest profitably in the summer months.
The UK market, like others around the world, was drifting off over the first nine months of 2001. Economies were growing more slowly and profits were under pressure.
Despite the action of the Federal Reserve in the US and the Bank of England's Monetary Policy Committee in taking aggressive action in quickly and repeatedly cutting interest rates, the markets were having to consider the possibility that the world was sliding into a synchronised global recession. In monetary policy terms, the European Central Bank was late to the party and only brought a bottle of cheap wine.
It was then necessary to digest the ramifications of the terrorist attacks on the US on 11 September. When Wall Street had reopened for business, it followed the downward leaning of other markets that had been able to keep trading. In late September, the most astute investors were able to see that share prices had driven to such low levels that good value had emerged.
As we now know, there was no recession. Indeed, the first economic slowdown of the millennium was both shallow and short lived. Those are not the only unusual characteristics for this latest business cycle. It wasn't triggered by rising interest rates but by a correction of over-investment and a build-up of the inventories.
One of the main reasons the downturn was short and shallow was because, untypically, consumption remained strong. Therein lies the problem. A revival of consumption usually drives the early stages of recovery. It can be a sustainable economic force.
This time around, the consumers' ability to step up spending is limited. Not only by the high levels at which spending has been maintained but also by the levels of indebtiness that have built up. The current upswing has been kicked off by inventory rebuilding. A positive influence, no doubt, but one that is unlikely to show durability beyond more than one or two quarters.
When that effect is washed through, what will follow it? Surely not capital investment with capacity utilisation at such low levels. That is why we are hearing so much talk of a double dip, with a second dip taking us into recession.
But remember, the brief, mild economic downturn was accompanied by a marked profits setback and it is a lack of profits that contributed to the market slide and the ballooning of P/E multiples. Even if the economic recovery falters or is lacklustre, profit ability and share prices can advance.
How can profits recover against this economic background? If revenues aren't rising, how can profits climb when we hear so often about companies' inability to increase margins? Two words are enough to answer this question: cost control.
For much of the late 1990s, many sectors of industry were dogged by margin contraction. To prosper, they had to learn how to be lean and mean. Last year, those lessons had to be applied again, but this time in order to survive. The result was that unemployment rose more quickly than normal in an economic slowdown, inventory levels likewise, and investment plans were slashed.
This time around, companies are not limping into recover but poised to exploit it. This time around, it will lead back to top-line growth. Not all companies, though. There are many in the TMT area that experienced a boom in the late 1990s.
They made all the mistakes so often associated with times when companies thought they could do no wrong. They have rewritten the rulebook and said it's different this time. They diversified, they paid too much and they threw caution to the wind. Just look at the chairman's statements for words to the effect of sticking to the knitting. How often have we heard these sentiments before?
We all share the guilt. We loaned these companies money and we invested in them. Some of them dominate indices like the FTSE 100 ' Vodafone to single out a name, perhaps unfairly. Such companies and the industries they dominate may struggle to advance.
So, why invest now? Look beyond these alien companies and there are businesses poised to prosper. We don't have to invest in companies just because they have high index weightings. If they are burdened with debt and pay too much for inappropriate acquisitions, avoid them. Invest in companies that didn't make those mistakes; invest in them now before everyone realises there is an upside to enjoy and profit from.
Why did the so-called growth companies do so well for a quarter for 2001? Partly because they seemed over sold and partly because the market value was equality driven and they held dominant positions in market industries.
The quarter just ended has seen some of those chickens, dodgy accounting practices included, come home to roost. Former growth companies' share prices have languished and market industries have been range bound. For the Vodafones of this world, the problems will persist throughout the summer and beyond. The prospect of resolving their problems won't lift their share prices, nor will liquidity.
I'm going to risk saying something that might be seen as contradicting myself. Sell in May recognises that market equality falls away in summer, while many of the movers and shakers of the market are enjoying the London season and taking their holidays. Even that may be different this year.
In the next few weeks, investors will get £9.5bn from bank dividends, £3.5bn for the Enterprise Oil bid and more than £3bn from the Energy takeover.
In the first half of this year, it is estimated, there will be a net return to UK shareholders of £41bn, 2.8% of the FTSE All-Share market capitalisation, which is big bucks or, to be more accurate, big sterling.
The money will become available and a home will have to be found for it. The index trackers and closet trackers may have to put their money where index weightings tell them.
Those of us chasing performance will look to put the money where it will do the most good ' with the lean, mean and focused companies that will deliver bottom-line performance.
For the most part, those companies aren't the leading lights of the FTSE 100. They can be found, rather like Chelsea Football Club, just a little down the rankings.
Some, like Brighton & Hove Albion, to remember Pavillion's roots, haven't made it to the Premiership yet but have just been promoted to the equity market equivalent of the Nationwide Division One, the FTSE Midcap Index.
How are we to find these gems in an environment of uncertainty, guarded management guidance and extrapolated analysts forecasts.
Industrial sectors have gone well as the better-than-expected signs of an economic recovery have emerged. But how much further is there to go?
The prospect of continued low interest rates has clearly benefited the construction and real estate sectors but benign inflationary expectations are waning and are likely to continue to do so. In addition, gross stocks are out of favour and look likely to remain so for sometime.
Our view is that a number of mid caps are reasonably valued and expectations for a muted recovery are realistic. The worst is over and we can now search for companies that are to continue benefiting from positive momentum in newsflow and investor expectations. Companies where we trust the management and believe in the product, companies that often accept more risk return for more profile, companies that offer evaluation yet to fairly reflect the prospects over the years to come.
Sectors offering such shares include life assurers, banks, support services and leisure. Obviously, many of the banks and life assurers are large companies but some of at the bottom of the FTSE and, in one or two of the cases, were only recently promoted.
There are some sectors that need to be treated wearily and these include construction and building, real estate and tech and telecom. The forces of capital markets that may seem so painful at times are subsequently providing us with opportunities.
Insolvency and covenant issues are giving way to consolidation and capital reorganisation. The playing fields are being levelled and new winners are emerging with Euro-capacity constraints and less competition.
Themes such as the changing media regulations and private finance initiatives will help us along the way. While in the longer term, productivity growth will continue and the long-term growth in technology has only just begun. It has been a long dark night in the land of equity markets and the sun is only just rising over the horizon but at least we can see it.
To me, there doesn't appear to be a need to define a theme that the markets can get it's teeth into at present. We're moving into a messy market where successful stock picking will beat the top-down hands down. The mid cap companies I'm talking about are quite capable of 25%-50% appreciation in the short term. They won't move the industries very far but they do offer the chance of serious outperformance. You won't get that from the big cap market leaders.
Let me recap: For equity investors, things are looking up. The economic background is supportive, if somewhat different from usual cycles. There's plenty of liquidity around and that is about to increase. There are plenty of companies offering superior growth and sitting on attractive valuations. Never forget that markets anticipate.
So, my message is simple: Don't sell in May, and don't go away.
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