Performance of index in 2011
Source: Financial Express Analytics
Caution is indicated, but portfolios should reflect this through stock and sector selection, rather than selling out of the market.
No sooner had results from industrial companies beaten expectations, than fears grew about further tightening in China. Now there is growing concern that it will not be the US Fed that leads the tightening cycle, but emerging markets.
China has already begun this, but other nations could also take action to stem the inflation that has been triggered by easy monetary policy in the West. Many emerging markets are likely to move to positive real interest rates, even before the West does.
Investors should be cautious now on financials. While bank shares bounced sharply in early 2009, most UK banks have underperformed since April of that year.
The weaker background in financials reflects the challenges of new regulations and a tougher tax regime, combined with problems in sovereign debt markets. Banks are likely to need further capital, and it is clear that there will be further impairments as sovereign debt is restructured.
No-one really knows the full implications of this. In addition, the final report of the UK Independent Banking Commission will not be known until September.
However, the outlook remains favourable in industrials. Companies continue to manage their businesses tightly. Strong cash flows are allowing the corporate sector to invest for the future, embark on mergers and acquisitions, return cash to shareholders and raise dividends – all while keeping balance sheets strong.
Many industrial businesses such as IMI, Croda and Yule Catto have restored their balance sheets and cut costs significantly. Profit margins are still below the best levels seen in the last cycle, and so there is scope for further progress. These companies are enjoying good upgrades to profit expectations.
With continued corporate recovery and attractive equity valuations, our portfolios emphasise industrials, energy, technology and luxury goods. Recognising stubbornly high inflation in China, we have reduced our commodity exposure.
In the West, stimulative monetary policy is likely to continue while unemployment is high. Slowly improving consumer and employment data, and a strong corporate sector, all support equities. We believe that share valuations are attractive, and markets can make further progress.
Margaret Lawson is the manager of the SVM UK Growth fund. The views expressed here are her own.