Cautiously optimistic

Just under one month ago I wrote about the investment junction which I feel portfolio managers are at. The asset-allocation decision regarding the shift of exposure away from fixed income securities into equities; thus taking on risk or taking off risk in their investment portfolios.

We are coming across a number of value stocks which are market leaders in their respective industries with dividend yields greater than the bond yields of the same issuer- Karl Micallef

Over the past weeks, some of the main issues we were seeing in the market have kept showing signs of improvement either through resolve or through continued macro-economic strength. It is important to bear in mind that the choice of words used in trying to describe the extent of improvement noticed need to be selected carefully. The reason for this is to try and give the reader the right feel to gauge this progress being witnessed.

We believe that the market is still in a very precarious state, however, it does seem as though equity markets have moved away from the doom and gloom scenario present in December. The rate of recovery will, undoubtedly, have to take its time given the size of the issue, but so long as progress is being made investors will need to adapt their investment strategy accordingly and allow time to heal the wounds.

More recently, the asset allocation between bonds and equities has increasingly become a major topic of discussion as we fully understand the importance of calling this right. Both sides of the argument are presented with strong cases – those who have converted look at equities more favourably, as they see a sustained continued recovery in the US and a Europe which is slowly (very slowly) gaining some traction – Greece is much closer to agreeing a debt swap with all stakeholders, Ireland has just been awarded full marks from the troika for their successful implementation of the programme, Portugal met its 2011 budget targets and Italy seems to have regained some credibility in the capital market. On the other hand, we have the unconverted who wish to see more evidence over the imminent future before agreeing that the worst is indeed behind us. One of the main issues I keep struggling with is economic growth. This is a fundamental ingredient for any recovery – growth which is, currently, not present (in any meaningful way) and neither can I see it coming in the imminent future (the US economy seems to be decoupling from Europe on this front). However, the European crisis does seem to have been halted from getting any worse. This current situation coupled with the fact that the market was, until very recently, pricing in a very gloomy economic scenario is now resulting in a number of blue chip companies trading at pretty attractive valuations.

Currently we are coming across a number of value stocks which are market leaders in their respective industries, with dividend yields greater than the bond yields of the same issuer, trading at almost single digit price-earnings multiples, with strong balance sheets and which also have good growth prospects if the economic recovery is sustained.

Therefore, while waiting to see how the rest of the year pans out, we are seeing increased scope of holding the equity instrument of a specific corporate rather than its debt capital because in some cases the dividend yield is giving the investor a return which is greater than the bond yield therefore allowing him/her to be more patient with the investment. Obviously this is a position that would also increase your overall risk profile – at least that is what modern portfolio theory suggests. One can also argue that holding a bond which is yielding a negative real return is also risky but we will come to this point another time. Today, we are cautiously more optimistic than we were a few months ago and I hope that matters keep moving in the right direction. Over recent weeks we have increased equity exposures in our investment portfolios, albeit in a very discreet manner, with line items which are backed by strong fundamentals and attractive dividend yields.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Any opinions that may be expressed here above should not be interpreted as investment advice, nor should they be considered as an offer to sell or buy an investment.

The company and/or the author may hold positions in any securities that might have been mentioned in this report. The value of investments may fall as well as rise and past performance is no guarantee of future performance. Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business.

www.curmiandpartners.com

Mr Micallef is an executive director at Curmi and Partners Ltd.