Market Commentary – 1st Quarter 2010

Are we nearly there yet?

If 2008 was the year of the financial crisis and 2009 of policy-induced healing, then 2010 will be the year of differentiation as some company shares fare better than others and we start to receive lots of mixed messages.

The best way to describe what we think will happen is to imagine that you are a child on a long car journey asking, are we nearly there yet? Only to be told there is still some way to go. On this journey you will see landmarks that make you think you have nearly arrived (these will be announcements from certain sectors that house prices are rising and people are buying). You will then hear contradictory news saying house prices are falling and unemployment is rising giving you the impression that there is a considerable distance left to travel.

It is easier to believe the good signs and ignore the bad ones but we believe that we are at the ‘start’ of this journey not the end. Although we feel that we have avoided the much discussed meltdown there are still some significant issues waiting in the wings. Our objective is to ensure that client portfolios are positioned to make the most of the new economic outlook. Despite the challenges ahead, we believe there are still considerable investment opportunities available for longer term investors.

To grasp an understanding of our strategy for 2010, you must go back to basics and ask why do we invest in shares? We buy a share of a company to get a share of the profits in the form of a dividend (very simplistic). We hope that the company will continue to sell its products and that there will be a demand for these products for the foreseeable future. As long as the company controls its costs and does not take too many risks then the future looks bright. The share price will fall and rise according to ‘market expectation’ on how much the company will make in terms of profits going forwards and thus the markets decide what price to pay per share.

As a company matures it diversifies into other areas in order to protect its income. This is why the ‘ice cream company’ might buy the ‘umbrella company’ so as to smooth out the returns over the year. This is also why the larger companies are generally viewed as safer investments as within the group they have a portfolio of products to sell.

The concern is how can we in the western world afford to pay more when the pricing pressures are all against us (pending tax rises and increasing unemployment)?
However, 51% of the world’s population in the BRIC economies (Brazil, Russia, India & China) have only just started to buy the things that we have long taken for granted, examples of these might be nappies or cans of fizzy drinks. Therefore those companies in the western world such as Nestle, Coca Cola, Heinz, Glaxosmithkline etc that have something to sell and have purchasers in the BRIC economies, will probably do very well in the coming years.

Normally these types of companies are expensive to buy into as you pay a premium for the ‘larger more secure company’. However appetite for risk is lower than normal post credit crunch so many of our best fund managers say that the valuations are the most attractive they have seen for a long time.

With interest rates likely to remain low for some time these global shares are providing not only a good prospect for growth but also a net dividend/income yield of between 3% to 6% per annum. A number of fund managers believe that they will grow their dividend yields in 2010 and beyond. We believe global equity income funds will prove a key element to an investor’s portfolio.

The chart below which is based on the last 139 years of the American S&P 500 index, highlights how important dividends are. Approximately 80% of total returns over rolling 5 year periods have come from dividends and dividend growth which are largely predictable.

However, if you take the average 1 year period 60% of total returns was reliant upon the growth in value of the stock which is largely unreliable. This is why we always advise clients to adopt at least a 5 year time frame for investments and to include dividend generating funds within portfolios.





Conclusions/Summary

The economic recovery is underway and investment markets have recovered strongly from the lowest points last year. However, there is a long way to go before economic conditions become normalised. It is likely that the UK will experience a long period of sub-trend growth which means investors must be prepared to invest on a more global basis. It is unlikely the level of returns witnessed in the second half of 2009 will be repeated in 2010 but certain areas of the equity market remain very good value.

Although bond markets are on a more sound footing, quantitative easing (QE) remains an issue. It is quite possible the banks will effectively take up QE later in the year by being obliged to increase their capital base via gilt holdings. We believe there is still value in the corporate bond sector and we currently favour the strategic bond offerings which provide the managers with greater flexibility.

After several difficult years, we expect commercial property to deliver positive returns in 2010. Rental yields of more than 7% compare very favourably with 10-year gilt yields of less than 4% and the returns on cash deposits.

Please note this document does not constitute specific financial advice and only provides our company views on the investment markets.