The insurance of diversity as markets change

This article is part of
‘Balanced Managed’ funds - February 2014

December 2013, overall, marked the end of a rather good year for equities.

Stock markets, namely those of developed regions, flourished amidst the consumer optimism encouraged by consistently positive economic data, and even managed to avoid the potential pot-holes of a renewed European sovereign debt crisis, geopolitical tension in the Middle East and the US debt ceiling impasse, which all threatened to derail stability at certain points along the way. When markets did experience volatility, however, it was more often than not linked to trepidation as to how much longer central banks would continue to provide markets with support. Markets have come to enjoy the cushion provided by central banks’ extremely accommodative monetary policy, in which they have provided ample liquidity and pushed interest rates close to zero. Consequently, the market experienced tremors whenever news of recovery of the US economy in particular appeared to nudge the US Federal Reserve (the Fed) towards the inevitable tapering of these liquidity injections. Even so, when the US Federal Reserve ended months of nervous market speculation by finally announcing a definitive start to tapering in the new year, most stock markets had grown to feel sufficiently reassured that this was a welcome sign of economic recovery, and reacted with unprecedented ease.

The optimism of the most recent economic data appears to bode well for the growth forecast for 2014, yet it will probably be necessary to keep expectations of the scale of the growth in check. While we expect respectable rates of growth we do not see a huge rise for developed markets, and even emerging markets will probably grow less rapidly than we have come to expect. That said, the coming year looks set to continue to favour equities over bonds, particularly as bond yields look likely to rise further as quantitative easing (QE) tapering continues. Equities are currently cheap compared to bonds and offer higher yields, and what’s more, the global picture looks pretty good.

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Surprisingly good economic data seems to have placed UK equities in particularly good stead with the rest of the global market, its 2013 annual return of +20.08% (as measured by the FTSE All-Share Index) falling short of global equity returns by a mere 0.6% in sterling terms (measured by the FTSE World Index). The FTSE 100’s top performers over 2013 have included household names like BT Group, Travis Perkins and Schroders. While large cap stocks can help to provide a solid and reliable core, however, it might be worth looking past it towards the FTSE 250 to find true value. Indeed, the FTSE 250 significantly outperformed the FTSE 100 in sterling terms over a ten year basis. The equity market often shows a degree of inefficiency, which means that a stock’s potential for high levels of growth and appreciation may not always be priced in by the market. Smaller stocks that cost less, yet look likely to appreciate in such a way, fall into the ‘value’ category. The stocks of large corporations and household names receive vast coverage in the media, by investment banks and brokers, and so it is less probable that the potential of such ‘growth’ stocks has not already been realised. Opportunities to buy (incorrectly) undervalued stocks are therefore more likely to occur among those that receive less coverage. Selecting stocks according to their ‘growth at a reasonable price’ or ‘GARP’ merits, however, can theoretically bridge this gap and offer the best of both worlds. What’s more, selecting GARP stocks that look able to capitalise on secular growth trends, such as population demographics, may also allow for the discovery of good value investments that herald growth in the long-term. UK-based house-building stocks, for example, currently appear to offer good prospects as they operate in a market of limited supply that is currently experiencing strong growth and demand. Conversely, sectors that currently experience intense public scrutiny and increasing regulations, such as financials, may not look as attractive at present, particularly those that are still attempting to emerge from the shadows of legacy issues. However, the rules are prone to change in a constantly evolving market, and a change in regulations has been known to suddenly increase the attractiveness of a sector or stock. Market leader BT, for example, has become an increasingly viable prospect following a relaxation of EU and UK regulation on how companies charge for broadband services. The market for 2014 as a whole looks to be heading away from the value sectors it tended to favour last year, towards growth-oriented sectors. Technology serves as a good example, where GARP might be found not in large brands such as Apple and Samsung, but rather in those that manufacture the component parts for these larger technology brands, such as UK domestic brand Information Technology.