Ten investment tips for 2013

Don't bank on a recovery in the West

Over the last year forecasts for global growth in 2013 have been stable at a little over 3 per cent on a purchasing power basis, and a little under 2.5 per cent on actual currencies. This is similar to the probable outturn for 2012.

However, divergence is likely to increase. Overall, growth in emerging economies is likely to remain strong and weak in developed markets.

Despite fiscal retrenchment in the US, we expect growth of 2 to 2.5 per cent.

The UK is held back by declining output from the North Sea, over-dependence on Europe for exports and a secular decline in financial services, but should still see growth not much lower than the US.

In Europe, the non-eurozone countries should see reasonable growth, northern Europe will struggle, but the economies of peripheral Europe will continue to spiral downwards.

Slow economic growth in developed markets will not necessarily prevent solid increases in corporate revenues and profits. 


Be selective with mega-caps

Market indices around the world are dominated by companies that have seen better days.

They look cheap and offer tempting dividend yields but often face serious strategic challenges.

Some will prosper and some rejuvenate themselves, but most are likely to continue to languish.

We believe small, mid and the smaller large-cap equities will outperform. We prefer quality growth stocks, especially in the cyclical sectors, well-judged recovery stocks and small and mid-cap stocks around the world. 


Resources equities can add value

In recent years, share price performances have varied enormously. The best companies have raised output, kept costs low, secured new resources on advantageous terms, avoided extravagant acquisitions or projects, kept debt comfortably affordable and returned cash to investors via dividends and buy-backs.

The companies that have been slow to learn are benefiting from new management and shareholder pressure. Provided commodity prices do not fall sharply, companies can continue to prosper.

Resource equities that can raise output and control costs should continue to prosper. Stockpicking has become key to successful investment in this sector. 


Look to emerging markets for opportunities

Emerging market equities are starting to perform better after nearly two years of underperformance.

They look undervalued relative to global equities on a price/earnings ratio (PE) discount of 14 per cent with similar earnings growth.

Any evidence of better translation of economic growth into corporate earnings would be very positive.

However, many developed market equities offer excellent and growing exposure to emerging markets, especially in the consumer sectors, which are poorly served in emerging markets.

Many of these are currently expensive, but attractive on a long-term basis. Emerging market debt should continue to be a bright spot in the global bond market, offering falling yields and appreciating currencies. 

---

Fiscal challenges are solvable with economic growth

The unwinding of the excessive leverage in developed markets is a major challenge, but while US investors have been pre-occupied with the fiscal cliff (the simultaneous expiration of the Bush-era tax cuts and the automatic imposition of spending cuts in January 2013), economic growth has already resulted in a one-third fall in the government deficit.

With bank balance sheets restored and consumer confidence rising, credit growth is firm in the US and likely to accelerate as the housing market improves.

This should ensure the growth that is the key to further deficit reduction. In the UK, deficit reduction should accelerate as real monetary growth resumes and economic growth picks up.

The intractable fiscal problems of the eurozone are not a precedent for other countries.

The investment implication is that pessimism about the outlook for the global economy (and hence equities) based on worries about the fiscal cliff is unjustified.

However a growing inflation risk threatens government bonds. 


Bet on modest equity market growth in 2013

Equity returns in 2012 have been satisfactory rather than strong, but after 18 months of corporate earnings forecasts being steadily eroded, we think stabilisation is in sight.

Forecasts for earnings growth for the last quarter of 2012 and for 2013 look realistic overall; this should ensure positive market returns and rather more if earnings growth looks likely to continue into 2014.

The upward path will not be smooth but any setbacks are likely to be modest, as they were in 2011. Reasonable valuations, earnings growth and support from dividend yields point to global equities being an attractive place to invest.


Beware of inflation

Even with an endless depression in much of the eurozone, inflation is expected to remain around 2 per cent.

In the US and UK, inflation is likely to be higher. The risks are to the upside; near-zero interest rates and continued quantitative easing will be very difficult to reverse in a timely manner if growth resumes.

Inflation may not be a problem in 2013 but could be thereafter if action is not taken to tighten policy in 2013.

With a return to positive real interest rates still a distant prospect, a further rise in the gold price looks likely.

The suggested investment implication is to hold physical gold. However, gold equities, which were severely disappointing in 2012, should perform much better if costs are controlled.

Inflation-indexed bonds should outperform conventional ones. 


Steer clear of developed market government bonds

Ten-year government bonds in the US, UK and Germany are likely to yield well below 2 per cent and in Japan well below 1 per cent.

Inflation continues to be stubborn everywhere except Japan, with any falls below 2 per cent only temporary. This means that government bonds offer negative real yields on any timescale, in our view.

While real yields in Japan may still be positive (just), the yen strength of recent years looks unlikely to be sustained as the authorities there seek to stimulate growth through a weaker currency.

Steady US growth will, in due course, lead to markets discounting higher interest rates, further undermining Treasury yields.

---

There is still value in higher-yielding areas of the bond market but returns are unlikely to be more than moderately positive.

The suggested investment implication is to avoid strategic positions in government bonds in developed markets. 


Don't bet on a dollar bull market just yet

The US economy is likely to grow faster in 2013 than other developed economies. Growth in the US is positive for the dollar, as it implies an end to quantitative easing and higher interest rates.

The US current account has improved significantly and the dollar is cheap on a trade-weighted basis. Still, the commitment by the Federal Reserve to maintain ultra-easy monetary policy until 2015 suggests it is too early to be a bull.

The suggested investment implication is that a bull market could emerge in 2013, but 2014 looks more likely at present.


Don’t try to trade the market

The first decade of the millennium brought two of the worst four bear markets since 1900.

The years 2010 and 2011 both saw significant corrections as investors, fearing a third occurrence, rushed to sell at the first sign of turbulence only to see markets rebound strongly.

In 2012, market corrections were much more modest as most investors had learned the lesson of not chasing markets in either direction.

Trading the market has meant no more than trying to arbitrage mood swings; it has usually destroyed value.

We believe 2013 is likely to be no different; investors should expect to invest for the long-term and accept the ebbs and flow of sentiment. 

Philip Saunders and Max King run the Investec Managed Growth fund. The views expressed here are their own.