The Financial Grand Prix Circuit

 

Stock Markets are racing ahead again and for the present I am happy to be going along for the ride.  I feel comfortable to be doing so in the knowledge that many people are still cynical about the Market recovery.  There is a vast amount of cash sitting on the side lines earning negligible interest.  As economic news improves, even if it is not fantastic, investors will find it harder not to join in the Market rally giving this phase of the Market recovery further legs.

 

In September last year I wrote that "the Markets will see light at the end of the tunnel and then it will be off to the races".    I was then addressed by a client who said "I bet you wish you had not said that".  In fact, I am happy to stand by that comment and, as usual, the Equity Markets have rallied strongly from the bottom.  Since early March, the FTSE 100 has risen over 1000 points in just over four months.

 

I am coming back to the subject of races though as I am struck by the similarity between the Investment World and the Formula One Grand Prix competition.  Both seem to be governed by regulators who are continually in the news for failing to govern properly, imposing high fines and failing to protect the interests of the people who pay their unjustifiably high wages.  Both seem to struggle to govern and are forever changing the rules after problems have arisen, rather than trying to prevent them in the first place.

 

Another similarity is the dominance of the 'stars'.  It is amazing how much money is invested with the Michael Schumacher of the Investment World, Neil Woodford, who controls over £15 billion at Invesco Perpetual.  The resemblance is their consistency and how they can adapt to different race tracks (economic conditions) and weather (trading conditions) but generally stick to their own proven methods.  Both also have a great team behind them, whether they be Mechanics (Ferrari) or Investment Analysts (Invesco Perpetual).

 

I was struck recently when watching the Monaco Grand Prix on television how even the lap  around the track was similar to the current Investment Market conditions.

 

At the time, in May, the World's Stock Markets were recovering sharply from the depths of uncertainty of last winter.  A sharp rally had taken place based on hope as much as any clear evidence of recovery in the economy.  Of course, the Markets had become very oversold due to fear and forced selling.  When Markets do this it is commonly described as "Climbing the Wall of Worry".

 

In Monaco the racing cars climb their own wall as they turn the first bend and head up the hill to Casino Square.  At this point they are forced to slow down as they enter a series of tight corners.  In mid May the Markets also were forced to slow down and there followed a period of consolidation where the Markets entered a trading range.

 

Over the last two months though, fundamentals have started to improve.  Banks, for instance, have generally announced good results and economic news has become less bad.  Further afield, in the Far East, there has even been surprisingly good news with the Chinese economy growing at an annualised rate of 7.9%.  This has had a knock-on benefit to the Commodity Market as China imports raw materials to continue its massive infrastructure projects.

 

Back in Monaco we have safely negotiated the last hairpin and are now accelerating into the fastest part of the circuit as we enter the famous tunnel.   Similarly the Equity Markets are also moving ahead rapidly as the latest economic and company news is generally better than expected.  There is scope for a reasonably long rally from here as, historically, major Markets still seem to be on low ratings.

 

Of course, it will not be a smooth ride and at times we will have to negotiate obstacles such as further poor economic news.  Unemployment, for instance, is likely to continue to rise for some time and inflationary concerns are likely to come to the fore from time to time.  Similarly, chicanes are put in the Grand Prix straights to slow cars down.

 

Eventually Markets will get ahead of themselves and a further period of consolidation will occur.  In fact, just like in Monaco, as they twist round the swimming pool area, the drivers (managers) will need to decide whether a pit stop is required (change of strategy).

 

At some point I think it will be necessary for our own pit stop to take profits and lock these in whilst reviewing the Market's potential.  I think it is quite likely that we will see a change in Market leadership at some point, as the focus changes from the cyclical shares to the value in the more defensive area of the Market.

 

Companies such as BP, Glaxo, Vodafone and National Grid are all paying very high dividends as their share prices fell along with the Markets last year when, in fact, they are all very resilient to the economic downturn.  Therefore I think at some point the Markets will re-rate these shares, especially as economic growth may be slower to return and interest rates could well remain lower for longer.

 

Of course, unlike a Grand Prix, the Markets never stop.  They do go through different cycles, just like drivers have to tackle different circuits in a season.

 

With the TB Wise Active Growth Fund I continually review our holdings, not only to find those that will perform best in the future, but also trying to avoid those which could disappoint (a bit like avoiding slick tyres in the rain!).   Fund Managers are no different to Grand Prix drivers.  Some perform better in Bull Markets, others when conditions are more tricky.  I analyse past performance and compare it to expected Market conditions to select those Managers for our team who are likely to produce better future performance and, more importantly, unlikely to crash.

 

Currently we are enjoying a period of good growth with a heavy weighting in Equities and Corporate Bonds.  The Fund is up 10.7% for the year to date compared to 4.9% for the FTSE 100 and 7.1% for the IMA Active Managed Sector.  (Source: Lipper 28/07/09). I am favouring investment in areas of greater growth potential and where economic growth is likely to return sooner.   Of course, the more profit we make the more I will be looking for attractive alternatives. 

 

For the time being I am just happy to go along for the ride as I know there are a lot of people who have missed out so far and will want to join the party.  At some point though we will take our own pit stop and put on a new set of tyres for the next lap in changing Market conditions.

 

This blog represents David Stephenson’s views as at 28^th July, and does not constitute financial advice.