A View From the Deckchair

Summer is here with clear blue skies and warm sunshine. Stock markets are traditionally quiet as traders take their August holidays. So what is the view from the deckchair? We still have deckchairs in Eastbourne but for city traders it will be the view from the pool at a luxury Greek villa. Surprise surprise there are small signs of economic growth breaking out all over the world including in China and the EuroZone. The recovery is still weak except perhaps in the US but business confidence is rising. So how are the markets looking? I offer a few random facts and observations from articles  I have read recently.

*Markets have diverged significantly in 2013. Those in developed economies such as the US, UK, Europe and Japan have risen whilst global emerging markets have fallen. The latter are out of favour, like run down seaside towns, notably with concerns over China  whilst the equity rally has favoured defensive growth stocks. Despite the negative sentiment the underlying fundamentals of emerging markets remain compelling for long term investors. Contrarian investors and regular savers please take note.

*Data from Standard & Poors (S&P) show that there were 219 increases in dividends paid by S&P 500 index companies and just 10 decreases in the first half of 2013. It is important to note that S&P 500 is a more representative index of the US stockmarket and economy than the Dow Jones Industrial Average. Whether earnings and dividend growth will remain strong in future years is unknown but with the US economy doing well the future looks bright from my deckchair for both US equity income and smaller companies – the latter are particularly dependent on the consumer economy which as I am sure you know makes up about 70% of the US economy.

*Fears of  a government bond bubble bursting with rising interest rates and yields have led to fixed interest managers scurrying to protect their portfolios from capital losses. Selling interest rate futures or buying short dated bonds are ways of reducing risk but there is a silver lining if interest rates rise; there is a corresponding expectation that credit risk will reduce. This occurs because interest rate rises are likely to occur as a result of economic  recovery. In such economic conditions corporate bonds are less likely to default because company earnings should improve. High yield corporate bonds or floating rate notes where coupons increase by inflation would be the obvious beneficiaries; both of these fixed interest classes are less interest rate sensitive than government bonds or investment grade corporates.

*Surprisingly ethical funds have done very well in the last 12 months compared to their unrestricted peers. This is a classic case of them benefiting from avoidance of an out of favour sector, miners.

*Much has been written about the great rotation. I refer to the much vaunted asset allocation shift from bonds to equities. Without a doubt equities offer greater value and capital growth potential and bonds carry risks from interest rate rises as well as tapering and withdrawal of Quantitative Easing. However according to data from Citigroup from March 2013 cited by Neptune fund managers the flow into equities from bonds and cash has been minimal. If so and equities remain attractive this rotation should pick up significantly and support rising markets.

*Japanese equities have been back in fashion like the latest swimwear and buyers have been out in force in the last year. A recent article in Investment Week interestingly suggested that fund managers have been buying back into the domestic companies and reducing exposure to traditional exporters such as car and electronic manufacturers which may have been overbought. This trend is supportive of the “New Japan,” focused on the consumer and the domestic economy. Medium and smaller companies will be obvious beneficiaries whilst an inflation target to encourage consumption will also benefit these.

As the summer holidays draw to an end and the deckchairs are put away the view for investors looks pretty positive for the autumn. There are plenty of opportunities to position portfolios to benefit from the identified trends but as usual individual financial advice should be sought.