Investment Adviser - A fresh start for investors in 2012
It's been said that many people look forward to the new year for a fresh start on old habits. While that may usually be taken as criticism, for investors in 2012 it could be sensible advice. The major events of 2011 that produced such startling levels of volatility – a sluggish global economy, a distressed banking sector, and the Euro-zone's precarious debt crisis – are likely to remain key themes for the coming year. We may always live in an uncertain world, but rarely can we as investors have been more conscious of it.
At best, the global economy is likely to plod along in 2012; at worst, it could tip into recession. While the possibility exists of a stock-market rally – particularly if politicians are able to act more decisively on the sovereign-debt problem – this seems unlikely. A sputtering market seems a more probable outcome. At the same time, though, companies are still making money, and we expect many of them to grow their profits, primarily on the back of demand from emerging markets. We favour the US and UK to Europe, Japan, and developed Asia, largely owing to differentials in sales growth. The UK equity market is underpinned by a strong increase in dividends and the depreciation of sterling, which is boosting exports; in the US, firms have put in place helpful cost-control measures, and the export market remains strong.
With economic concerns predominating, company valuations have become of secondary importance, yet in the UK they are slowly becoming more attractive. Margins at many firms, particularly those in the industrial sector, are back above their peak levels of 2007-08 – and management teams feel better prepared to weather any storms.
Strong cashflows have also benefited corporate bonds, another area we favour. While the volatility of the underlying government bond market will affect total returns from time to time, balance sheets are healthy and levels of default low. This is one area of the market to keep a mindful eye on in 2012. Government bonds hold slightly less appeal, particularly in Europe, where investors remain concerned about the slow progress on the Euro-zone's fiscal difficulties. In the US, yields are being supported by muted inflation pressures and the ongoing quantitative easing programme, but the worsening fiscal outlook and expensive valuations are slowly becoming a concern. UK gilts have arguably reached expensive levels.
In UK property, occupier demand has shown signs of slowing, but yields remain attractive. We are cautious on the commodities front, where higher prices, brought on by strong demand, have encouraged new supply and a stronger dollar is encouraging negative investment flows.
Our portfolios are likely to maintain their sustainable income bias for the foreseeable future. At the same time, we are mindful of the opportunities that such extreme volatility can present. Fund managers will need to think about the medium-term inflation risk, particularly if the economic recovery gathers momentum. For the likely bumpy ride ahead, advisers would be best to take a structured and consistent approach to developing their clients' portfolios, with regular monitoring and rebalancing. Those who aren't accustomed to doing so might wish to start the year with at least one new habit.
Bambos Hambi, Head of Fund of Funds Management, Standard Life Investments
First Published in Investment Adviser on 9th January 2012