It's a constant stream of bad news on the economy.  When will it stop?  Will it stop?  Will there be a recovery?

 

Uncertainty, coupled to a lack of confidence in the World's financial system, has led to almost indiscriminate selling of financial assets.  The only safe havens so far have been Government Bonds, the yields of which have fallen to record lows.

 

In the UK, 10 Year Gilt yields have fallen to just above 3% whilst in the US and Germany they are even lower.  As Warren Buffet has stated, the World has gone from under pricing risk to over pricing risk.  Inversely I think it is now over pricing safety.

 

As of today you could buy a Treasury 4.5% Gilt due to mature in 2019.  The cost for £100 nominal stock would be £112.40.  Every year for 10 years you would receive £4.50 gross, i.e. a total of £45 but at the end of the period you would get back only £100, i.e.  a loss of £12.40.  To maintain its real value, if inflation were 2% you would need to receive back £137.  If you were to pay basic rate tax on the interest your total return of capital, plus interest, would only be £136.  Despite this Gilts are selling like hot cakes.

 

On the other hand there are relatively safe companies out there that are still growing profits and will be little affected by the recession.  Take BAT, a tobacco company.  It came out with results at the end of February.  Its profits increased 23% over the previous year and it raised its dividend by 26%.

 

Over five years the Share price has risen 119% and dividends have risen from 39.7p to 69.7p a Share.  Yet the Share price is actually down over 12% since it peaked in January last year, despite having a yield for next year of 3.9% net of basic rate tax.

 

Where would you rather have your money invested?  Anyone taking a medium term view has got to find  BAT more appealing.  Yes there are no guarantees but the company is targeting high single digit growth and has a record of achievement.

 

The Stock Market is littered with solid companies like Tesco, National Grid, Vodafone and Glaxo who are all yielding substantially more than Gilts.  Other companies such as BP, Shell, BT, Aviva and Astra Zeneca are yielding many times more than Gilts.  This is because they have temporary issues that make their dividend payments less certain.

 

For instance, BP is yielding over 10% because the price of oil has fallen.  Remember 8 months ago there was an oil shortage so I suspect this worry will not last.  BT has got a pension fund deficit which will need a substantial part of its profits to fund for the next few years.    However, BT's problem is compounded by the Stock Market falling and eventually it will benefit when Markets rise.

 

Over the long term investors will be rewarded by these companies but in the short term prices could go lower.  However, the more they fall the more attractive they become so at some point there will be a substantial rally as happened last time we saw such a significant sell off in 1974.

 

For me, as a Fund Manager, it is a delicate balancing act.  Primarily we want to achieve positive long term returns.  At present the most attractive assets keep falling in price whereas unattractive assets, like Government Bonds, keep rising which will eventually lead to big capital losses for those who do not get out before the peak of this bubble which has grown as a result of recent Government policy action, quantitative easing.

 

The key is this uncertainty, once the mist lifts and fears of depression recede, we will see a scramble to invest in real assets as economies gradually recover.

 

Remember that the World's population is still growing and, despite the set back to wealth in the western economies, there are millions of new consumers in the Far East, an area which has little debt and a high level of personal savings.

 

Commodities including oil, metals and agricultural products have a limited supply so when demand returns prices will rise.

 

The difference this time, compared to the great depression of the 1930s, is that central banks have taken exactly the opposite action.  Everything that can be done to make the economy work will be done.  This will probably mean lower interest rates for longer and lead to longer term inflation as Governments effectively print money.

 

In the Wise Active Growth Fund I have been trying to balance these issues.  The majority of the Fund is invested in Equity Funds investing in larger companies with stable businesses.  I am still avoiding Funds that favour Banks or other financial assets.  Around 25% of the Fund is now invested in Fixed Interest Funds and Cash.  However, I have started to reduce the largest holding, Thames River Global Bond, which has actually risen over 23% since we first purchased the Fund in August last year.  Proceeds from this sale will gradually be re-invested in Funds offering greater long term potential including UK Corporate Bonds, UK Equities and Far Eastern Equities.

 

As a result, if Markets continue to fall so will the Fund, albeit at a slower pace than the Market overall.  Since the start of the year, for instance, the Fund has fallen 10% whereas the FTSE All Share Index is down 18.3% (Source:  Lipper 06/03/09).  However, by crystallising gains in Funds that have performed well and I consider overvalued and re-investing in Equity Funds at substantially lower prices, we should benefit from a recovery when it arrives.  Every recession since 1950 has seen a large rebound in Share prices before the recession finished and I expect this time will be no different.  It is only the timing that I cannot forecast.

 

This blog contains the personal views of David Stephenson as at March 9^th, and does not constitute financial advice.