Investment outlook for 2009

This time last year, the investment world’s crystal ball gazers were forecasting tough times ahead. Markets had been volatile in the wake of the US sub-prime mortgage crisis, rising oil prices and a weakening dollar, while the run on Northern Rock reminded us all that the credit crisis was not just a US problem. The contagion was spreading and it was heading our way.

Even with such a negative backdrop, few experts could have predicted what was in store for 2008. In September, the collapse of Lehman Brothers rocked the world and it quickly became clear just how much our banks were struggling too.

Following a monumental collapse in its share price, HBOS was forced into merger talks with Lloyds TSB, while Bradford & Bingley was brought to its knees and saw its business sold off to the government and Banco Santander, the Spanish banking giant, which had only just scooped up Alliance & Leicester. Then came the downfall of Iceland, taking billions of pounds worth of money from UK savers, councils and charities.

House prices continued to fall, while the stockmarket crashed with billions of pounds being wiped off our pensions, nest-eggs and life savings.

At the start of 2008, the FTSE 100 was riding high at more than 6,500 but, by the end of October, it had fallen to 3,660 and at the end of December it was sitting just a little higher at 4,318.

After five years of rising markets, the current turmoil poses some tough choices for those looking to review their portfolios or start an investment plan in 2009.

If there is one thing that the events of 2008 have taught us, it is that predicting what could happen over the next 12 months is a tough call. However, with the world’s major economies in recession, the experts agree that there’s more pain in the pipeline.

Recession 

As 2008 drew to a close, the Confederation of British Industry was estimating that the UK economy would shrink by 1.7% in 2009 (down from forecast growth of 0.3% in September). It was also forecasting an increase in unemployment, expecting it to peak at about three million.

“I am very nervous about the state of the UK economy,” says Tony Lanning, head of multi-manager at Gartmore. “I can’t see any real end until 2010.”

Julian Chillingworth, chief investment officer at Rathbones, takes a similar line and says we can’t expect to see positive economic growth for another 12 months. “It’s going to be a pretty difficult year. It’s not dissimilar to the 1990s: The housing market is soft and unemployment will be picking up fast through Christmas, the New Year and beyond. This all started as a financial crisis, but it is now very much on the high street.”

Darius McDermott, managing director of Chelsea Financial Services, is perhaps a bit more upbeat saying the recession is likely to last between six and 12 months, but he warns that stockmarket volatility will continue.

During tough times, cash usually looks like a safe haven. But, for savers used to earning 6% plus, this is one asset class that now looks distinctly unappealing.

In December, the Bank of England’s interest rate was slashed to 2% and, with many in the City now expecting it to fall below 1%, savers will barely see their money grow. In fact, once tax and inflation have been taken into account, many people, especially higher-rate taxpayers, will lose money in real terms.

Bonds are back

For these reasons, McDermott believes investors should be considering higher-yielding assets like bonds and equities. “I’ve never seen yields on equities like it: M&S is providing a dividend of 8.8%, BP 5.7%, HSBC 8.1% and Vodafone 6.9%. Even if returns remain level you would be receiving up to three times more than cash deposits.” He adds:

Corporate bond funds are currently offering outstanding value when compared with gilts - yielding anywhere between 5% and 13%.”

With yields like these, it’s no surprise that corporate bond fund managers are smiling as nervous investors seek a halfway house between cash and equities. In mid-November, Henderson reported that investment in its bond funds were up by 60% on 2007’s total while M&G reported the biggest inflows in five years.

“The market is trading at ludicrously cheap levels,” says John Patullo, manager of Henderson’s Preference and Bond fund. “We do expect more companies to default, but that has been priced into the market and we have so much coupon coming in that we can tolerate a few defaults.”

But while corporate bonds will no doubt enjoy this moment in the sun, investors that hold their nerve throughout the recession and remain in equities are likely to be rewarded. If you attempt to time the market by dipping in and out, you’re likely to miss the most profitable days.

“Just as everyone thinks bull markets will carry on rising, the same can be said for bear markets,” says Mark Dampier, head of research at Hargreaves Lansdown. “It’s worth remembering that stockmarkets typically anticipate recoveries six to nine months before the economy bottoms.” And, while there is almost certainly more volatility ahead, the fact remains that equity valuations are looking incredibly cheap.

Lanning says that investors who don’t need their cash in a hurry should carry on drip-feeding money into the markets. “You need to continually review your strategy and ensure you’re properly diversified. Over the short term there will be more volatility but, over the long term, stockmarket investing will be fruitful.”

In fact, Dampier says young investors should be increasing contributions if they can afford it. “Volatility is good so long as markets do rise eventually as you buy up more units while they’re cheap.”

Defensive

The key will come down to selecting those fund managers who are best able to chart these stormy waters without giving you sleepless nights. For most investors, that means sticking with managers who are investing defensively.

“We prefer large cap UK stocks at the moment,” says Lanning. “We’re investing away from home builders and the high street and we’re underweight in consumer stocks. It’s too early to get back into small and mid-size companies.”

Mick Gilligan, fund analyst at Killik and Company, agrees and points out that, as sterling continues to weaken, larger companies with earnings outside of the UK – such as BP, British American Tobacco and Glaxo SmithKline – are likely to fare better. “Small to mid-cap companies are too geared into the domestic economy and that’s not the place to be right now.”

Equity income funds could also make sense for moderate-risk investors because, even though stockmarkets may fall, they’ll still pay a dividend. “Lots of equity income funds are yielding 5% net at the moment,” says Dampier.

Ticking both the defensive and the income boxes are the Invesco Perpetual Income and High Income funds run by Neil Woodford. Gilligan says: “His top-down economic view has been spot on. He hasn’t held banks in at least three years and there’s very little cyclicality in the funds.”

For more risk-tolerant investors, Gilligan likes the Blackrock UK Dynamic fund run by Mark Lyttleton. “It’s a pro-cyclical fund with more exposure to mining and energy stocks.”

Special situations

Braver investors may also want to consider special situations funds, says McDermott. While many managers in the field have been investing in resilient large cap companies in recent months, they will be shifting into smaller and mid-size companies ahead of the recovery.

Richard Plackett, manager of BlackRock’s UK Smaller Companies and Special Situations fund, says it’s at this end of the spectrum where next year’s best opportunities lie. “If you go back to 2003, which was a recovery year, small to mid-cap stocks had a very poor start but, over the year as a whole, they did very well and continued to outperform for three years.”

McDermott likes the proven management of the Artemis Special Situations fund run by Derek Stuart and the M&G Recovery fund run by Tom Dobell. “Both managers are top-decile over the last five years.”

Go global 

Many experts believe that global stockmarkets will pick up before the UK. “The outlook for the global economy in 2009 is better than the UK. Sterling is falling and that’s going to be a big advantage for overseas companies,” says Plackett.

With the US entering recession first, it’s largely expected to be the first one out. “If you’ve got an appetite for risk, you shouldn’t be avoiding the US,” says Lanning. Chillingworth adds that many large cap US companies are looking good value.

Mark Mobius, manager of the Templeton Emerging Markets Investment Trust, is particularly upbeat about the world’s newer economies.

While the credit crisis has no doubt hit these countries, it’s not enough to stand in the way of their long-term development. “Emerging markets are growing at a rate of five or six times developed nations and that has to be reflected in stockmarkets.”

But McDermott warns against investors chasing hot markets. “Emerging markets are very frothy and around nine out of 10 are on the risk scale. There’s a currency risk and a political risk.”

Gilligan is equally cautious. “Everything may stack up in terms of valuations but the big unknown is just how much of a sell-off and deleveraging we are going to see over the coming months.” He favours emerging markets funds that are diversified across a number of regions.

At the moment he rates City of London Emerging World, with its broad spread of regions. A rounder global fund will however, by definition be more diversified. In particular McDermott likes Rathbone Global Opportunities managed by James Thompson.

Whether you favour cash, bonds or stick with the stockmarkets, investing in 2009 will carry a risk. Play it too safe and you could end up missing out on a recovery, speculate and there’s a danger you’ll lose more money.

This lack of certainty is a useful reminder of the rules of successful investing. While uncertainty may make you worry, prompting you to flock to safety or encouraging you speculate to recoup your losses, it is not the time for rash decisions. A more sensible New Year’s resolution is to sit back, take stock and review your portfolio. Only then will you know whether you need to find a better home for your cash.