In this article we discuss a short selection of observed trends, which could stimulate some stock selection ideas.
What’s going up
• Smaller companies
The FTSE 100 was up 14 per cent in 2013 – well above the long run average for equities as an asset class of around six to seven per cent per annum. However, it pales when compared to the FTSE 250 (after the FTSE 100 constituents, the UK’s next largest 250 quoted companies) outperformed by some margin – up 29 per cent.
This is not merely a UK phenomenon. The Japanese Smaller Companies sector, for example, was up 36 per cent. 2012 was also a year of outperformance for mid caps. Over a 10-year horizon the FTSE 250 has delivered more than double the return of the FTSE 100, around 270 per cent versus 115 per cent respectively.
That said, it should be noted that the FTSE 100 is still trading at a discount to its historical valuation, while the FTSE 250 is trading at a premium.
• Inequality
US President Barack Obama recently said: “(We) understand that our country cannot succeed when a shrinking few do very well and a growing many barely make it. We believe that America’s prosperity must rest upon the broad shoulders of a rising middle class.'
He is correct. The evidence, however, suggests that there is a widening gulf between the wealthy and the poor. It has been estimated that the top 100 Americans are more wealthy than the bottom 150 million. This phenomenon extends beyond the US. Oxfam calculate that the richest 85 people in the world have the same wealth as the poorer half of the world population. Why is this happening, and why does it matter? In brief, it is happening because of a combination of a number of factors – such as imbalances between regressive and progressive taxes, capital taking an increasing share of GDP relative to labour, globalisation, technology, intergenerational effects, and a general disinclination to introduce wealth taxes to square off and redistribute. Since the 1970s, the US middle class has suffered a declining share of GDP.
It matters because it is inequitable, and for investors it matters because it points to a trend of declining disposal income for a whole raft of society – and companies highly exposed to it are going to suffer. Henry Ford understood that he must pay his workers enough to be able to afford the (mass market) cars they were producing. Direct causes and effects are seldom clear in today’s complex economy, and to an extent it is the very complexity which is causing the imbalances to remain unidentified and unaddressed, but Ford’s observation remains a relevant concept.
• London commercial property
London property headlines tend to focus on residential. More quietly, commercial property has also been attracting vast amounts of capital. Savills report the value of London commercial transactions amounted to £21bn in 2013. That is a record, up an astonishing 39 per cent compared to 2012. Asian investors were the main drivers, in itself a reflection of where growth is being generated. Forward confidence indicators are strong. Companies such as British Land offer good exposure to this trend.
What’s going down
• Gold
The gold price has been retreating sharply, from $1,694 to $1,205/oz during the course of 2013. The weakness is understandable, in the context of a market perceiving less risk. There appears to be no short-term potential catalyst to reverse the declines, although the risks that made the metal attractive in the first place are possibly dormant, not eliminated – a small exposure in the interests of diversification may be warranted.
• Global emerging markets
On May 22, Ben Bernanke, in a congressional hearing, did not deny that the Fed could soon start tapering back bond purchases. This triggered a sharp decline in emerging market indices. Increased volatility is to be expected, and could provide a window of opportunity to buy into economies which, at four per cent, are growing much faster than developed countries and have more favourable demographics. Our favoured strategy is to consider global names, such as Nestlé and Unilever, which have good exposure to an emerging middle class in emerging markets and in addition offer solid corporate governance structures which are well understood by Western investors.
• Eurozone periphery inflation
So far, the word of emphasis in the eurozone has been ‘austerity’. Recent inflation data suggests that the rational policy shift is to stimulate demand.
Ireland, Greece, Cyprus, Spain and Portugal are in a deflationary environment, or close to it. Since these are all highly indebted nations, the burden is increased. If prices are perceived to be falling, expenditure will be delayed and demand driven growth will be stunted.
As things stand, the euro could conceivably remain strong against the dollar despite a general perception that it is overvalued. Even as the Fed starts to taper, asset purchases will remain significant and act as a dampener on the dollar. With a clear consensus for it to fall, eurodollar has surprise potential in 2014.
A key factor is whether German savers can be stimulated to start spending, to drag the periphery out. It will be interesting to see to what extent the ECB is prepared to act if deflation fears take root. It might be forced into buying assets outright. In this scenario, we would expect eurozone equities to perform well.
info@curmiandpartners.com
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.
Martin Webster is head of equity research at Curmi and Partners.