Watching over the main markets of the world, plus quite a few of the exotic ones, on a regular basis — as your investment team does for you — can mean that we begin to ‘pigeon hole’. What I mean by that is that entire currencies, markets and asset classes can gain horribly dismissive labels.
Nevertheless, the process enables us to identify and emphasise the main money making opportunities as they evolve — and bring you ways to profit from them. With that in mind, here are the labels that summarise our key thoughts this month:
Why careful stock picking will keep us ahead of the markets
Positive — commodities, UK equities, emerging market equities. But we tread with care: stock selection is perhaps more important than ever in emerging markets. Using all our contacts and original analysis, we should keep your money growing far better than the overall markets.
Negative — bonds, US equities, US dollar. But that won’t prevent us from picking specific special situation stock plays in the US — where we think we can offset the negative currency implications with the size of the stock price increase.
And so it is that we dare to return once more this month to some themes we’ve presented to you before: themes and trends that are vital to increasing your wealth. We don’t apologize for retreading the commodity story, even though Eric Roseman covered it just last month. It’s that important. And it’s not just higher commodity prices that fire us up. It’s not just the equally important China and India growth phenomenon.
It’s that the inflationary impact of commodities on the manufacturing chain has yet to sink in. UK engineering — which had been enjoying something of a renaissance in the stock market — are beginning to squeak. But with manufacturing accounting for just 17% or so of GDP, the UK economy can take pain in the engineering sector in its stride.
Don’t underestimate the power of the oil trend
The biggest wild card and threat to investors remains oil. Too many economic forecasts are still based on oil priced below $30 per barrel, whereas the current $50 level has every prospect of being maintained or exceeded. Indeed in a year’s time, $50 could seem cheap. We cannot stress enough that every portfolio should have positive exposure to a higher oil price.
Looking at UK equities, you’ll have seen that our picks generally come from the ranks of the mid- and small-cap indices. That’s where markets are least efficient and where careful research can pay the biggest dividends.
UK market looks very cheap compared to Wall Street
The large cap FTSE 100, though, does offer extraordinary appeal right now. On a P/E ratio (PER) of 15.4x and a dividend yield of 3.7%, the index is cheap by international standards. And international exposure is what the FTSE 100 increasingly offers. Global banks such as HSBC and RBS plus oil majors BP and Shell dominate it. Other major constituents include mobile telecoms and pharmaceuticals, two sectors that have been out of favour in recent years. That PER equates to an earnings yield (if all earnings were paid out as dividends) of 6.5% (1/15.4), comfortably ahead of the risk-free return of 4.85% offered by 10-year gilts.
A number of stars have aligned for emerging market equities. Again we are painting with a very broad brush, but resource-backed economies of the emerging world are benefiting from higher commodity prices. A weak US dollar generally helps their exports and reduces the burden of notorious emerging market debt levels. The consumer story too has wheels, while in developed markets with high personal debt levels, the consumer spending wheels look set to seize up. At the fore of emerging markets, Russia this month received a credit rating upgrade.
Get more news on emerging markets
By the way, do make sure you sign up for Sven Lorenz’s free email, The Lorenz Files for more news on emerging markets ideas. Sven is the guy who brought you such hidden gems as Holsten (where we took 70% from a takeover), PEH Wertpapier and Hansabank, the Estonian Bank currently up over 120% on takeover rumours.
Our negative stance on bonds and most things US dollar denominated follows naturally from the above. Higher commodity prices, particularly oil, point to inflation and inflation is the scourge of bonds.
Revisiting the relative valuations of the FTSE 100 and gilts, which should a rational investor hold? A fixed return of 4.85% on gilts set to be eroded by inflation or an equity earnings yield of 6.5%, which has the prospect of being increased in an inflationary environment because of companies’ pricing power? On Wall Street the case for equities is not clear-cut. The S&P 500 sits on a price earnings ratio of 18.6x, equivalent to an earnings yield of 5.3% (1/18.6), while 10-year Treasuries yield 4.5%. Throw in exposure to the US dollar, which we would rather avoid, and US equities do not cut it for us unless in special situations.
The US dollar has been enjoying a reprieve, but the reasons for its continuing weakness remain in place. South Korea, with the fourth largest foreign currency reserves in the world, has joined the swelling ranks of concerned dollar holders, citing the Canadian and Australian dollars as potential alternatives. No coincidence, we feel, that these are resource-backed currencies. Canada, notably, has crude oil reserves greater than those of Saudi Arabia. With the higher oil price making more of those reserves commercially realisable for the first time, the Koreans are talking sense.
Armed with some oil insurance, we continue to advocate exposure to the companies in our portfolio. With the UK reporting season at its peak, our cup is brimming with updates this month
.Budget Tinkering
In the UK, the Chancellor presented his annual Budget speech just as we went to press. From an economist’s view point it is a case of ‘no change’. As investors, two items grabbed us straight away. The £7k annual ISA allowance will now be extended until 2010, and the introduction of REITS draws a step closer. We will be commenting in more detail next month.
ANDREW VAUGHAN, INVESTMENT DIRECTOR
