Investors traditionally look forward to a healthy market rally up to Christmas. After the travails o...
Investors traditionally look forward to a healthy market rally up to Christmas. After the travails of October, however, this may seem a trifle optimistic but I believe market volatility during this autumn should be taken as a positive when viewed as part of a long term trend, rather than a worrying sign of further problems to come.
Global markets were alarmed by profit warnings emanating from the US over the past couple of months. The underlying reason for the warnings has been the slowing of demand, which has caught many companies by surprise.
The severity of the downturn in growth company share prices has forced investors to look far more closely at the characteristics of technology related companies; are they really immune from economic conditions, or are they in fact more cyclical than their old economy peers? It adds an element of cynicism into a market that has been prepared to take some spurious projections at face value this year.
So why would a background of slowing economic growth and a more cynical investment climate be positive for UK growth companies? Both create the conditions for a peak in the interest rate cycle. Markets are likely to move in response to the turn in the interest rate cycle long before it actually happens.
Therefore, investors should be looking towards the strategy to adopt in an environment of falling rates in order to position portfolios for the next few months. This will have several implications.
Firstly, as the most interest rate sensitive section of the market, the environment will remain positive for smaller companies. This year has seen an improvement of sentiment towards smaller companies but there is still a long way to go before they regain ratings that reflect their growth prospects.
Related to this, if only because share prices have fallen so much that they find themselves classified as smaller companies, housebuilders look set fair. Their share prices have been de-rated continuously in recent years despite many achieving very creditable profits growth. On a quarter of the market rating, this sector often has a run from November through to March and this year it has every chance of doing so.
Finally, a background of falling rates and a rising market will be particularly positive for financials.
On the negative side, I believe that those expecting technology stocks to lead the way may be disappointed. The prospect of falling rates may be viewed as a positive but the risk premium accorded these companies has significantly increased and this will take time to reverse.
The real turkeys this Christmas are likely to continue to be the industrial stocks. Although falling rates may reduce debt burdens, the dollar remains strong and the euro weak. For many industrial companies this increases input costs and reduces output prices.
Nick Brind is a fund manager at Exeter Capital Growth Fund
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