As with 2011, the investment tug-of-war this year is likely to be fought between the bleak macro-economic environment and the rather better-looking corporate environment. In 2011, it was the macro-economic environment that won, and the best performing areas were safe havens such as gold and gilts. Yet company profits have so far held up admirably – so will 2012 be different?
It is important to recognise that GDP growth – or contraction – does not directly translate to stock market performance. We only have to look at China for that. Whilst growth has continued apace, the stock market has been dire. The reverse can also be true. Some companies can thrive despite wider economic difficulties. Fund managers who focus on the prospects for individual firms can therefore outperform when forecasting economic events becomes impossible. A prime example is Anthony Cross of Liontrust special situations who has continued to show what a good stock picker he is throughout 2011.
Another manager who dislikes spending too much time on the macro picture is Nick Train. Alongside Michael Lindsell he launched the Lindsell Train global equity fund in March, and his portfolio has coped exceptionally well in the subsequent volatility. Their focus is on large, international companies with strong brands and a high level of cash generation. It has been precisely the right place to be in recent months and I believe it should continue to thrive in the coming year.
For most investors, however, the eurozone crisis is too big to ignore. I believe it will rumble on until politicians are forced to act – probably under the strain of market pressure. Eventually the Germans will have to cave in and begin the process of quantitative easing unless they want to trigger a depression. It is just a question of how severe things get before they do.
Although this would be eventually be good news for risk assets I can see it simply moving the focus elsewhere. The inability of US politicians to make decisions is worrying, as is the possibility China will find it difficult to engineer a soft landing in an environment of slowing global demand. A substantial slowdown in China would have grave consequences for the world economy. Finally, there is political risk. As Niall Ferguson pointed out in a recent seminar I attended, Iran is on the verge of enriching uranium and any nuclear weapons programmes is likely to be met with a strong response from Israel. How will Obama act when woken at 3am to be told Israeli fighter jets are in the air?
For all these reasons I will be keeping some money with fund managers of a bearish or cautious disposition. These include Philip Gibbs of Jupiter absolute return and Martin Gray of Miton strategic portfolio. Leonard Charlton of Melchior European absolute return is also a manager worth considering, and while many absolute funds have failed to deliver he has continued to thrive.
With interest rates set to remain low throughout 2012 income is likely to represent a particularly important component of investor returns, and I expect high-yielding equity funds to remain popular. Two of my favourites are Bill Mott’s PSigma income, which showed a real improvement last year, and Neil Woodford, the stalwart of Invesco Perpetual high income. Bond funds too look good value. They will have the potential fallout from the Eurozone to deal with, but much of this could already be factored into prices. M&G optimal income and Jupiter strategic bond are my slightly more cautious picks here, but should we see a solution to the eurozone crisis, financial bonds could rally fast and Paul Read and Paul Causer’s Invesco Perpetual tactical bond fund is likely to make a comeback.
Finally, for the brave and contrarians among you, two of the cheapest markets according to our own research are Europe and Japan. Richard Pease of Henderson European special situations and Stephen Harker of GLG Japan are my favoured managers here. Incredibly the Japanese market is at a similar level to 1983, and both areas are unwanted, unloved and deeply unfashionable. They may be the surprise package of 2012.
My general feeling is that 2012 is going to be another volatile year. The best course of action is to ensure clients have a thoroughly diversified portfolio of different asset types and strategies, and not to simply rely on geographic diversity.