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.
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:
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.”
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.”
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.”
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.
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.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Confederation of British Industry
The CBI promotes the interests of its members, some 200,000 British businesses, a figure that includes 80% of FTSE 100 companies and around 50% of FTSE 350 companies. Formed in 1965, it’s the lobbying organisation for UK business on national and international issues and seeks to influence the UK government to help businesses compete effectively.