Concern over financial institutions that have taken on a higher level of risk, particularly in the US sub-prime mortgage sector, has led the market, in part, to a flight to quality as concerns arise over short-term liquidity. This shift in emphasis in risk could lead the market to defensive large-cap stocks.
We want to take advantage of inflation as higher prices means higher profits. We are keen on is oil and are overweight in major integrated oil companies such as BP and Shell but also some of the smaller E&P stocks. We also like the mining sector, which has performed well already but we believe is in a so-called supercycle where interest from China, the Far East and India are going to keep driving up metal prices. We do not think the company values reflect current metal prices and stocks are cheap. They also enjoy strong cashflow, which will either result in M&A activity or better returns for investors.
We have taken advantage of food price inflation by being overweight in selected food and beverage producing companies, a recent example being Dairy Crest. We also expect food retailers to benefit as they tend to add a little more to prices for themselves so their margins are quite good.
Other areas where we are positive are telecoms – both mobile and fixed line – because these are still growth markets and tend to be less cyclical. We also like the aerospace sector – possibly our favourite area – with big holdings, particularly in Rolls Royce, which is in a strong position in the civil aviation cycle.
We are underweight in domestically focused retail-sensitive sectors such as retail stores, as with interest rates rising and debt high, there will be pressure on these stocks. None of the major name stores appears in the portfolio at present but we expect some good opportunities to come up in the sector in the next year to buy into retailers at lower prices.
We are not keen on banks, especially mortgage banks where pressure is emerging. We are also shy of property companies, where asset values are coming under pressure, and negative on utilities that are highly valued ahead of regulatory reviews. We expect the market volatility to continue, at least in the short term, opening up opportunities.
Richard Moore is equity fund manager at Santander Asset Management