Despite bear market conditions and exceptionally high volatility, some 85% of fund managers expect 2002 to be a good year for equities, according to the latest survey from Merrill Lynch
It takes more than a bear market to shake the professional optimism of fund managers. Despite negative returns in 2000 and 2001 ' or the fact that, despite exceptionally high volatility, the All-Share has delivered meagre returns to investors who bought four years ago ' 85% of managers expect 2002 to be a good year for equities, according to the latest Merrill Lynch survey
The strong rally since the bear market nadir of 21 September has revived confidence in a way that would scarcely have seemed possible at the time of the terrorist attacks. Accelerated cuts in interest rates and massive support for the financial system by central banks has invigorated investors and bolstered their conviction that a healthy economic recovery is in the offing by the second half of the year. The main issue now is whether this scenario develops according to plan and if the accompanying positive corporate newsflow underwrites a new bull phase or recovery hopes are subject to unforeseen complications.
In our globalised stock market environment, US data will set the trend, starting with company results and trading updates in January and February.
Any generalised hint of stabilisation or improvement would confirm the bullish mood of investors and enable them to continue buying in the face of valuations, which already partly discount recovery.
This is not the whole story, however. Rather, it is the tactical view on the short-term outlook for UK shares. We need to probe deeper for a more considered view on longer-range prospects.
Retail investors are always being urged by fund managers to take the long-term view on equity investment. Pensions, Isas and other savings products are essentially long-term in scope, not trading accounts.
Taking the long view worked very well for most of the 1980s and 1990s. Simply buying an index fund and holding it would have delivered handsome returns. The evidence suggests many investors retain a residual optimism, despite recent mishaps. In the US, for example, mutual fund holders still anticipate long-term annual returns of the order of 17%. Their experience since 1998 has been quite different.
In volatile market conditions, the surest route to making money is to trade ' to buy low and sell high. Buying the market at the two low points, autumn 1998 and autumn 2001, and selling at subsequent peaks, would have produced substantial gains. But taking advantage of exceptional volatility is an activity fraught with risk.
Is there another way? Two approaches are worth considering: thematic investing and adding particular value by effective stock selection within a firm investment discipline. Both are well-established methods with positive performance track records over the past four testing years.
While history seldom repeats itself, it does contain elements that provide valuable lessons for the future. Thematic investment has certainly worked well in recent, highly-polarised markets. Look more closely at 2001, a year in which the FTSE All-Share delivered a negative total return of 15%. Weakening economic growth and dwindling market confidence dramatically lowered investors' appetite for risk, prompting them to favour defensive sectors. Thus, while technology, media and telecoms sectors in the UK declined by some 40% overall, and the FTSE 350 Lower Yield Index declined by 26.5%, the return on the FTSE 350 Higher Yield Index was only -2%.
Income funds satisfied both the demand for defensiveness and the search for income in a low interest rate environment. On the other hand, growth funds were inherently disadvantaged and only a handful outperformed the index.
The issue was not whether an investor was exposed to the stock market but which sectors or themes were emphasised and which avoided. Looking into 2002, assuming a healthier global economic environment, it is likely interest in growth stocks will be sustained. Examining the growth credentials of investment candidates is an approach calculated to identify exciting growth companies and reduce the scope for expensive mistakes.
If confidence is sustained, it is probable there will be an accompanying increase in fund raising, either view rights issues or IPOs. However, there will probably also be a revival in merger/acquisition activity and well-managed growth funds should benefit from a following wind, in contrast to 2001.
The highly polarised stock market environment of recent years is sometimes described as a stockpickers' market. The requirements are selectivity, rigorous stock selection and a well-ordered investment process. However, the real essence of success for this approach lies in the ability of a fund manager to harness an established methodology to a feel for the market and an instinct for selecting shares that will perform outstandingly well.
Whatever the economic environment, there are always opportunities and anomalies that escape most fund managers, especially those who have become increasingly wedded to a closet index approach.
The timing of buying and selling decisions, as well as the actual stock selected, makes a substantial difference. Even if out-turn in 2002 is as positive as most of the strategists predict, it is unlikely to be notably less volatile than recent years. That is why, although I am a natural optimist, I am happy to seek out opportunities whatever the market environment.
Strong market rally since 21 September has revived investor confidence.
US economic data will set the trend on a global basis.
In volatile markets, surest way to make money is buying low and selling high.
An ambitious objective
'Something completely new'
'Illusion of control'
Reasons to be cheerful
Total investment reaches £9m