2009 has potentially been one of the most difficult years in living memory for investors. The FTSE100 Index has probably been as volatile as anyone can remember, falling from 4561 at the start of the year to about 3500 in March and recovering to today’s levels of around 5200 (Source: Yahoo Finance 11 December 2009). In the first quarter, fear significantly influenced investors’ emotions as uncertainty remained over the global financial systems. After March, unprecedented low interest rates helped a rally into markets, with all major asset classes showing substantial improvements to the level at which we see them today.
The December Pre-Budget Report contains no announcements which will significantly affect the UK economy overall. Instead, it appears to be a tactical pre-election political (rather than economic) statement. (Source: Capital Economics 9 December 2009).
For clients who retain Cash deposits, current retail deposit rates (around 3% to 3.5%) are still relatively attractive, with private clients still benefiting from interest rates which remain substantially in excess of Bank of England Base Rates. For other holders of cash (trusts, pension funds and corporate entities, for example), rates are typically much more similar to Base Rate.
Holders of Corporate Bond funds have not been immune to stock market volatility in 2008-9. The Bond market encountered its own problems which have mostly been resolved in 2009. Nevertheless, this experience has shown the importance of active management when investing in Bonds. Choosing an experienced Bond fund manager with a demonstrable track record through difficult times has never been more important. Higher risk Bonds (known as High Yield or non-Investment Grade) have generally performed best in 2009 but even the lowest risk Investment Grade Bonds have seen returns over 13% (Source: Financial Express UK Corporate Bond Sector Performance 1 January to 10 December 2009). There is disagreement as to whether holders of Bonds should sell at these prices or whether there is still the likelihood for positive returns in the future. Our view is that Bonds remain good investments for lower-risk clients now, as future valuation falls should only occur when interest rates and/or inflation rises or companies start to default on their debt obligations. On balance, our view is that any of these eventualities are unlikely in the short term (say 2 years).
Investors in Bond funds could look to diversify between Investment Grade and High Yield by use of “Strategic” funds, where the decision as to which investment offers better prospects is delegated to the fund manager.
The UK stock market is not directly linked to the UK economy. This statement must be true given the recovery of the FTSE100 Index shown at the start of this commentary. The outlook for the UK economy still appears poor, with potential problems surrounding our “AAA” Sovereign Debt Rating, the weakness of sterling, increasing public sector indebtedness, increasing unemployment and a consumer who may be switching from spending to saving. There will be UK companies which are affected by these problems. There could be many more UK companies which can ride this storm on the benefits of earnings from overseas activities (which is said to make up 70% of the earnings of FTSE100 companies (Source: M&G November 2009). Smaller Companies may appear more vulnerable but our discussions with some fund managers in this area remain positive. Growth prospects remain strong and share prices could be protected by Merger and Acquisition activities from overseas acquirers, buying into the weakness of companies valued in sterling.
The potential problems indicated in the above paragraph strengthen our view that UK Gilts should continue to be avoided for the foreseeable future.
Investing globally might be the best tip for 2010. Certain global economies are not affected by the structural problems of the UK indicated previously. If sterling continues to devalue, holdings of investments denominated in other currencies should appreciate, even without investment growth. Investment growth should accelerate the net return. (Clearly the opposite would have a negative impact with investment losses being increased by strengthening sterling). If the Chinese and Indian middle classes, in particular, continue to prosper, Asian markets could continue to move positively despite any problems which may occur in the developed world. (Technically, investing globally could be said to be of higher risk to UK investors due to fluctuating currencies. Our view is that this fluctuation should have a positive rather than a negative impact due to the issues mentioned previously relating to the UK economy).
It is inappropriate to make a call on which global market offers the best investment opportunity. Instead we would suggest that investors should diversify across all global markets, if they have the capacity to accept the risks involved. Again, there are some investment funds which involve delegating the geographic decision to the fund manager and we favour such funds in current market conditions.
UK Property Funds are currently receiving net new money inflows for the first time in years (Source: SWIP October 2009). Commercial Property prices have fallen 44% (Source: IPD September 2009) peak to trough and appear to have stabilised. Future yields still appear uncertain and could be negatively affected by voids due to supply and demand imbalances and corporate insolvencies/rationalisations/cost cutting. Nevertheless, some yields now look very attractive (particularly in relation to cash deposits). It might now be appropriate for investors to start to reallocate to UK Commercial Property investments.
Global Property Funds have already recovered (Source: Financial Express 9 December 2009) with the substantial increases in Global Equity Markets and no longer appear cheap.
I have commented on Commodities in previous reviews and would restate my position that investors should diversify into such investments. Commodity prices may bounce further when global demand returns.
To plan finances sensibly, clients and Pearson Jones’ Consultants must make educated assumptions for the future. To provide a basis for this, the following “House View” should prove useful.
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Historic Long Term Average (Source: Sarasin January 2008) since 1900
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Pearson Jones “House View” over short-medium term (short-term = 1-2 years; medium-term = 3-5 years)
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Inflation
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3.9% p.a.
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Below average short-term reverting to average in the medium term. Short term risk of deflation. Remains a threat of high inflation medium-term.
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Equity Returns
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9.5% p.a.
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Unpredictable short term reverting to average in the medium term.
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Gilt Returns
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5.2% p.a.
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Below average short term remaining so for the medium term
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Cash Interest Rates
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5.0% p.a.
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Well below average short to medium term with little likelihood of increasing substantially
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Past performance is no guide to the future and no statement in this commentary constitutes any form of individual advice or guarantee.
Information in this document represents a consensus of views from various sources including those of Pearson Jones plc. Readers should not act on the comments made in this document without the benefit of Independent Financial Advice from a Pearson Jones Consultant.
PETER HECKINGBOTTOM FCIB APFS
Chartered Financial Planner
Deputy Managing Director & Investment Director
peter.heckingbottom@pearson-jones.co.uk