The technology, media and telecoms surge of late 1999 and early 2000 seemed to condemn income funds ...
The technology, media and telecoms surge of late 1999 and early 2000 seemed to condemn income funds to being yesterday's story.
Having a long-term record of outperformance against growth funds, traditional income investing came to be seen as a laggard and some commentators even went so far as to sound the its death knell. Of course the last three quarters of 2000 have removed some of these critics' swagger, but the important question is what happens from here.
The price volatility of the past 18 months reinforces the lesson that the UK equity market is far more influenced by shorter term, hot money today than in the past. The greater use of index tracking funds enhances rather than detracts from this trend. For the vast majority of technology stocks there has been no problem with the fundamentals. It was just the share prices became wrong by order of magnitude. The case was similar, but in reverse, with the majority of old economy stocks.
As we move forward, it is tempting to think that the market will be more discerning, picking managements and strategies, rather than taking an all or nothing approach to sectors. However, it is far more likely that the short-term volatility will continue and it will only be over the long term that consistency of delivery finds its reward.
Where should we look for the next leg of performance? Clearly recent performance has been driven by some of the more defensive yielding areas of the market such as utilities and tobacco.
However, recent economic data has pointed towards the likelihood of interest rate reductions both here and in the US. Defensive areas of the market have become too highly rated and interest rate sensitivity should deliver outperformance in the first half of 2001. In this respect it is encouraging that the recent tech sell-off has led to a contraction in media ratings to put many stocks in this area back on the income list.
Having been zero-weighted in the sector early in 2000, the Higher Income fund is now fully weighted. It should also be noted that technology stocks have confirmed their position as cyclical growth stocks and may also benefit in a falling interest rate environment.
Valuation attractions existed without an obvious catalyst. Now falling interest rates are marching over the horizon, the valuation attractions have already fled.
The valuation point remains critical. Growth at any price has proven to be fool's gold, as will defensiveness at any price. However, the interest rate outlook is based on the premise of slowing growth on both sides of the Atlantic, and this will inevitably lead to some downgrading of economically sensitive stocks. Investors must beware that there is room in the valuation for a downgrade and that the direction of interest rates will, therefore, be the driver of share price performance.
Toby Thompson is Fund Manager of the Newton Higher Income Fund
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