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Taking stock of the recovery

Darron Preston, investment manager at Aventus, considers market prospects as the recovery starts to take a tentative hold

There is no doubt the markets have been tremendous for those who took the bull by the horns back in March and ploughed money in. Anyone who believes that the best time to buy is at times of maximum pessimism would have been piling into the markets from late January onwards.

After all, the common view back then was that the global economy faced a new Great Depression and the end of capitalism.

Since then, we have seen the Dow rise by 60 per cent over six months and the FTSE 100 up by almost 50 per cent but has the situation improved sufficiently to warrant investment?

There are two camps, those who invested in the early part of the year and those who thought it was a bear market rally and are still largely storing up cash. Of those that chose to invest, most have been taking profits over the past month.

The common theme is that neither group knows where we are headed in the near term. That economic indicators have improved is not in doubt but the question remains as to whether this is purely down to the restocking of the pipeline, global stimulus and cost- cutting or if it is a sustainable recovery? A further complication is inflation versus deflation, a matter of which will prevail and when.

It is generally accepted in economic theory that increased stimulus (quantitative easing) will inevitably lead to rising asset prices and inflation. However, due to a breakdown in the transmission systems as banks are forced to improve balance sheets by hoarding cash, the likelihood of a big surplus of capacity and little chance of a wage-push as employers remain stretched, there is little sign that inflation will take off in the near term.

One has to wonder how much spare capacity there is in the system. Many companies have cut back but to what degree has capacity been permanently lost due to closures and bankruptcy?

My own take is there is a greater likelihood of inflation, but only down the line. If economic conditions improve sufficiently, banks will ease up and cash will enter the system. The key will be how effective the authorities are in anticipating this and removing the “new cash”.

But that is a longer-term problem. In the short term, the market depends on the recovery’s sustainability.

Looking at recent economic data, while the economy has improved, the data is still fragile. More interesting is the Baltic Dry index, which has come off sharply since its peak in June but is still double that seen in the depths of the crisis at the end of 2008. Given the vast increase in Chinese imports of copper and other commodities, this seems odd unless it means global trade is still slow.

All in all, there seems to be too much uncertainty in the market right now. Analyst forecasts have been increased, but are the improved (or less worse) conditions now priced in? My guess is that Q3 figures will be the key to another significant move in the markets. If the results confirm the recovery, then the markets will be strongly supported, due to all the cash sat on the sidelines. If they disappoint, as I feel they probably will, we could easily see a 15 per cent retracement.

Economic indicators have improved but the question remains as to whether this is a sustainable recovery

The interesting bit will be to see how the cash-holders, especially those who missed the March lows, react to such a fall. They could use it as an opportunity to put in some of their cash holdings, thus limiting any decline.

Many companies out there look decent long-term value but the short term seems just too uncertain and I have been struggling to find companies I like at a decent enough price to offset such doubts.

Once we have the Q3 figures, and therefore a sense of where stock-pricing is, we can look at the strength of the economic pick-up on a localised basis, that is for the West, and start to ask how national budgets can be improved without hurting economic growth?

What can we conclude from all this?

It is hard, if not impossible, to form a solid long-term plan amid such uncertainty but forward planning should aim to cover as many outcomes as possible. For us, that means being long on commodities as a hedge against inflation, a play on global recovery, internal Asian and emerging market growth and continued strategic purchases by the Chinese.

In the ultra long term, we still feel the peak oil argument will support prices.

Otherwise, our focus is on global earnings and firms with an emphasis on emerging market development and infrastructure. Strategically, we remain wary of the domestic UK economy. We also carry significant cash balances now in order to trade opportunities as they arise.

Perhaps the answer is that there is no clear long-term strategy that will work, just a series of short-term cycles. After all, as Keynes said, in the long term, we are all dead.


Adviser Fund Index

More than just a blip, the pound’s recent slide could signal the start of a prolonged period of weaker sterling, according to Adviser Fund Index panellists. Last week, sterling flirted with six-month lows against the euro and dropped to its lowest point against the dollar since May. The precipitous falls have been read by some […]


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