Speculation, it's what markets run on

Today started in a panic as Cyprus announced a levy against depositors. The Euro fell against all major currency peers and the word spread of Cypriots rushing to ATMs to withdraw their money. At first glance it sounds bad, however the actual implications for global markets were more speculative.  The real cause of markets falling was contagion risk and the possibility of a run on the banking system in Europe.  

If you haven’t guessed it already, the markets are driven by human emotions not just the facts and the two most powerful drivers are greed and fear.  Today was clearly the latter and with a measured approach you could have capitalised on this. 

From my trading days, I learnt a few lessons about this, the futures markets are a constant battle against your peers, be it to be first in the queue on a certain price or strategies for obtaining profits. The psychology of investing plays a fundamental role and understanding how people react to news can help you make important decisions.

An overreaction to bad news is usually the case, and it is not until people weigh the news and data when a correct price is established.  As mentioned in buying on the dips, after major news, be it company specific or global, heavy sell offs present opportunities.                 

On the flip side, over the weekend, news emerged about a possible £8bn bid for M&S by Qatari Investors.  Subsequently the share price rose 7% on Monday and whilst there have been reports this is not true, it just goes to show the power speculation has. 

As the saying goes, “speculate to accumulate!”

Importing inflation

We have spoken previously about currencies and how a depreciating currency can be a benefit in many ways, not least making exports more competitive. However, one of the bi-products can be 'importing inflation'. 

Think about the price of petrol at your local garage, I bet it has become more expensive over recent weeks?! This is not due to a spike in the oil price, simply it's down to Sterling weakening against the USD and therefore making oil (priced in USD) more expensive. This will be occurring with many other imports, not just oil. 

It is often the case that with this type of inflation consumers do not fully feel the effects for a year or so, as prices do not change instantaneously, and so it could be that the real pinch of inflation occurs in 2014. CPI (consumer price index) last peaked in September 2011 at 5.4%. Given the poor state of the recovery it didn't lead to wage inflation. High levels of wage inflation can be very bad for businesses as costs (wages) spiral out of control. At this point in time I still don't feel employees have enough bargaining power to demand large wage increases should high levels of inflation occur, but it could be one to watch. Businesses with pricing power, which have the ability to pass costs onto consumers are normally desirable in this situation as they can maintain margins.

Having a strategy to implement in your portfolios to hedge against inflation could be something worth considering....

An Alternative to Cash?

A question many people are asking at the moment is, “where can I put my money when cash is returning so little”?

Well the answer is pretty limited… For investors not wanting to take any risk, fixed term deposits are the ideal place, however with the best rates at around 2% per annum it is hardly a viable option for those trying to match liabilities or at least beat inflation at 3%. 

Investors are being forced to take more risk than they would prefer.  So let’s look at the alternatives.

• ·         Fixed Interest/Bonds – these will offer little more than cash at the moment, government debt is yielding around 2%, and investment grade corporates are not much higher.  High Yield will be your best alternative at around 5-6% per annum.  With yields at record lows, long duration funds will be very sensitive to interest rate rises.  Therefore I would be fairly against this option, unless you can access short duration funds, such as AXA U.S High Yield Short Duration Fund.
• ·         Equities – there are a number of high yielding equities out there, however this is a risky option.  A number of UK equity income funds yield above 4% per annum, with some up towards 6-7%.  This option has the potential for added capital growth as well.  If you are looking to go for this option, more defensive funds such as Troy Trojan Income would be my choice.  This has excellent performance over the long term with a relatively low volatility.
• ·         Absolute Return Strategies - whilst these do not provide an income this may be suitable for those who do not require liability matching.   Absolute return strategies aim to provide absolute returns over the medium to long term.  Typical return aims are LIBOR + 4-6% per annum.  This is not as secure as holding cash however downside risk is fairly low as a multi asset approach is combined with derivative strategies.  This sector has been growing as more people seek alternatives to cash, it also acts as a great diversifier in any investment portfolio.   A number of examples are Standard Life’s Global Absolute Return Strategies which is now over £20bn in size, Insight’s Absolute Insight Fund which is a combination of absolute return funds offering a more diverse holding and Newton Real Return.

This hopefully provides you with a few alternatives to cash, but the reality of it is, until interest rates increase, more risk will have to be taken to obtain returns.

What next for the High Street?

The decline of the UK High Street is there for everyone to see. Walk round your local town centre and I'm sure you will notice many more vacant units than 5 or 10 years ago. Prime retail zones like Oxford Street in London buck this trend but in many other regions in the UK it is apparent. 

The High Street has faced two main headwinds. One has been the Credit Crunch; in a nutshell reducing consumer's ability to spend. Second has been the Internet; online shopping from sites such as amazon has boomed in recent years making the High Street redundant. Without expensive property and staff costs these online businesses can drive down price, stealing market share. Recently we have seen Comet and Peacocks close down, highlighting the structural shift occurring in this sector. 

So what does this mean to investors? Well one thing to consider is property investments. Retail property may not be the best investment currently as empty rates are likely to be at highs historically and there could be a lack of rental growth as demand falls. Retail stocks with businesses in structural decline should also be avoided; they may look cheap but they are likely to be 'value traps' and keep getting cheaper! 

Opportunities could arise from retail businesses with a strong online presence. Amazon is a prime example of this type of successful online business model. 

It is not all doom and gloom for the UK High Street and this was highlighted by John Lewis who recently announced strong profit growth as well as staff bonuses of 17% across the whole business. This company has integrated successfully into the online market whilst also benefiting from the success of Waitrose. Strong management has seen this business adapt and change and this dynamic approach has seen it succeed and grow market share when many peers have struggled.

For now let's make the most of the UK High Streets, in 10years time the landscape could look a lot different.

The importance of income

For many investors assets that produce a natural income are often highly desirable. Typically people automatically gravitate towards bonds and property for this income, however given the potential headwinds facing these asset classes equity income may become more desirable.

Since the credit crunch UK Equity Income funds have been very popular. I think this is for two main reasons. Firstly in a low growth environment income becomes a bigger part of total return and helps underpin portfolio growth and does help offset any erosion in capital. The second reason is down to the nature of business that pays dividends. These businesses are usually seen as 'defensives' with stable and predictable cash flows, allowing them to return cash to investors on a regular basis. Since the credit crunch many investors have favoured these more defensive businesses that are more resilient during economic downturns. 

There are many funds available to investors wishing to have exposure to UK Equity Income stocks. Probably the most famous is Neil Woodford's Invesco Perpetual Income and High Income funds. These funds hold stocks like AstraZeneca (c.6% yield), British American Tobacco (c. 4% yield) and Rolls Royce (c. 3.5% yield). I would argue however that this fund is now too large and that some of the smaller, more nimble funds are likely to perform better and also contain less stock specific risk. Neil Woodford has large allocations to a handful of companies which could add a layer of risk. Unicorn UK Income has been the stand out performer over recent years, and other funds such as Royal London UK Equity Income also have excellent track records. 

So when looking for income from investments, equities should be considered. Many businesses are available on attractive yields, and often grow these dividends as well as having the potential for capital growth, something bonds don't offer. Many corporates are also flush with cash on their balance sheets so we may see special dividends, with even more cash returned to investors!

Rural Expansion and the Control of Urbanization

The process of economic development usually begins in the capital city, or most built up areas.  As we have seen with China over the last decade, rapid expansion occurred within its major cities prompting a necessity for huge investment in infrastructure and housing.

This pathway to becoming a developed economic country is a tricky one as acceleration within urban areas can cause the economy to collapse onto itself if this occurs too quickly.

China, over the past decade has had double digit growth as a cheap workforce stormed this huge nation into a competitive superiority over other developed countries.  As with all things, this cannot go on forever.  Industry and construction fuelled demand on a global scale for raw materials and machinery boosting company profits around the world.  Infrastructure spending in China was vast, Bejing’s underground railway had only two lines up until the start of the century, today there are 15 lines spanning  300 miles, with just under 8 million people using it daily and further expansion planned.  As with the underground system, housing has expanded at a similar pace.  With urban areas reaching capacity, there are a number concerns around the state of the economy in China.  The property market has seen rapid price increases and the government has warned it may increase taxes on second homes in order to curb further inflows into the property market.

The problem arises from rapid expansion in the urban areas, with little development outside.  This results in a greater demand for the built up areas causing a further divide.   This process is unsustainable and will eventually lead to asset bubbles and subsequent crashes.  A tempered approach is needed to structurally grow the rural areas as well.   In China this is starting to occur, but savvy infrastructure spending is a necessity.  

China has a long way to go in developing its vast nation further, but with wage increases and growth slowing, a number of hurdles are still to come.  The property and banking sectors are in my opinion the areas of major concern.  Such a rapid demand for new homes and mortgages begs the question, can these people repay their debt?  If this is not controlled, it may lead to a banking crisis similar to what we saw in 2008.

Enough about China… Another major economic player is Latin America.  Brazil especially has seen similar rises in its urban areas (maybe not at such an extreme pace).  With a majority of the wealth within its major cities, there will come a point where more rural areas begin to follow suit.

Wage inflation has started to occur and demand for more mature food stuffs are on the up.  There is much development still needed. The amenities available in rural areas are slim, and this follows through into demand for temporary measures such as generators.  Companies benefiting from this specifically are Aggreko, the largest generator maker globally.  Also, JCB announced strong demand for their vehicles(diggers) as construction ahead of the Rio Olympics is well under way.  After some good results recently, it is inherent demand in emerging markets is on the up and up. 

Emerging market investment funds will be your best bet to capture some of this upside.  First State Global Emerging Market Leaders would be my choice, however with such a pull on infrastructure spending still such a necessity, First States Global Listed Infrastructure fund is prime for growth.

These rapidly expanding countries have the size and ability to become some of the leading economies in the world, however it will not be a smooth ride and the management of growth throughout the whole country is needed.

Technology - Onwards and Upwards!

As I look around I am surrounded by technology, from mobile phones to laptops to a washing machine.  All of which have been developed over a relatively short space of time, and it is now hard imagine a life without it all.

Today the technology industry brings in around $500bn worth of revenue each year and this still expanding!  As we become more dependent on advancements in technology it offers a great investment prospect going forward.

Most investors would remember the Tech boom in the mid to late 90s, this is when everything really started kicking off and a mass investment into advancing tech products was made.  Since then we have seen companies such as Google and Apple rise to become some of the biggest companies in the world.   

Unfortunately technology doesn't stand still, as Apple has seen recently, with a gap until their next product, many investors have become wary of future revenue generation and subsequently the share price has fallen.  The likes of Samsung have taken this challenge in their stride.  With a number of avenues, their new Galaxy S4 phone has been released only 6 months since their last.

Probably the most famous company now is Apple, and it is worth mentioning.  As one of the largest companies in the world, their revenue growth has been second to none.  With as much cash as Poland it is hard to see this company disappearing any time soon.  With many doubting their future product line, it is only a matter of time before they produce another.  With huge resources at their disposal, it is definitely one to hold onto for the long term.

Technology is as we all know very changeable, and when investing in such companies it is important to have a diverse number from this sector.  Encompassing some of the core companies mentioned already I would recommend investing in AXA Framlington Global Tech, which has been an excellent performer over the long term, or alternatively Cavendish Technology. 

For years to come this sector will be hugely profitable and would be a good addition to any portfolio.  

Asset Managers - a leveraged way to play a rising market

Over the past 12 months the number of available asset classes which have produced competent returns has been diminishing and as a result many have moved into equities.  This increased flow of money into equities has proved great news for asset managers as they make up significant proportion of equity investments.

The asset managers came under pressure after the credit crisis as many ran to cash to protect themselves from heavy losses. Unsurprisingly share prices collapsed along with the market. Since then assets have been slowly building back up gathering pace over the past year. A number of companies have reported increased profits as a result.

Increasing demand for equity funds has rolled through from institutional, retail investors and Wealth Managers.   As the asset managers have experienced gains at the end of the line, further towards the front, Wealth Managers have experienced a similar trend.  Since the introduction of the Retail Distribution Review (RDR) at the start of 2013 this separated the good from the bad and a number of wealth managers have taken this in their stride increasing assets under management.

Namely Brooks MacDonald, announcing an increase of 44% in discretionary assets over the year and raising their dividend is a prime example. Also St James’ Place and Hargreaves Lansdown have also benefited all be it from slightly different avenues.

With banks still having a number of structural issues, many investors are wary of jumping back in. These other alternatives to the financial sector have great growth potential, especially as these mid cap stocks have room to grow and increase their dividends going forward.

This rotation into equities may have only just begun which is great news for both asset and wealth managers a like.  Without going out and buying a number of these stocks directly, I would suggest purchasing Guinness' Global Money Manager Fund that invests solely in asset managers and has performed very well over the past year, returning 34%!

Auto Sales - A Sign of Improvement

Construction and industry are what many great nations have been built on. In the midst of the industrial revolution the first automotive was created in 1806, since then they have played a fundamental role in the growth of the global economy.  Now around 62 million cars are sold around the world each year. 

During the credit crisis one of the most affected sectors hit was the automotive industry.  As many see cars as a luxury, new car purchases crashed to the floor.  A number of companies sought emergency loans, most notably GM Motors, Ford and Chrysler receiving a record bailout from the U.S and Canadian government of around $85bn. 

These big three have recovered somewhat since 2008, however global competition has been ever increasing.   Since the start of the Eurozone, Germany its primary contributor has benefited hugely and as one of the major producers of cars they have seen profits rise significantly on the back of a weaker currency. 

Asia follows suit as currency plays a key role in exports.  Japan has historically been a major producer of cars, such as Toyota and Honda.  However, these companies have been hampered over recent years by the strengthening Yen and until recently has had trouble competing with the likes of South Korea and China. Since the introduction of the new Prime Minister, Shinzo Abe, the Yen has weakened significantly by around 20% and this will inadvertently roll through to company profits. 

The gathering pace in automotive industry should start to show in company profits by April, and a number of funds are well positioned for this.  Aberdeen Japan Growth and JOHCM Japan have a heavy weighting in the automotive sector and would be my pick.

Over the past twelve months, we have seen consecutive rises in auto sales and this is a good sign the global recovery is gathering pace.  This lagging indicator has a powerful message and is one to look out for.

Mergers and Acquisitions – A Pathway to Growth

Since the credit crisis M&A activity has been fairly low as companies aimed to strengthen their balance sheets and reduce debt levels.  Over the past five years, this global restructuring has meant these companies are in some respects the strongest they have ever been.

The start of this year has seen a rapid increase in M&A activity as companies utilize high levels of cash to expand.  Such companies as Dell and private equity firm Silver Lake Partners agreeing a leveraged buyout to take the company private.  Virgin Media, also agreed a takeover by Liberty Global for $23.3bn, and Warren Buffet’s Berkshire Capital acquired Heinz for $23bn to take it private.  

Larger companies have historically had no problem in achieving good year on year growth, however markets have now changed and in many countries growth is anaemic.  The changing demographics weigh on government spending and will inadvertently reduce expansion and demand for many businesses for years to come.  A possible area for companies to expand are to takeover business which are in the growth phase, allowing larger companies to capitalise on growth elsewhere without having to expand existing operations.  

So why now, what has caused this activity to pick so much since last year? Markets have calmed significantly and volatility has been gradually decreasing.  There is a slight correlation between M&A and volatility and this is inherent in the great start we have had this year.

There are a number of factors which are helping company mergers and acquisitions.  Interest rates are at historic lows, and yields on even the highest yielding debt are the lowest it has ever been.  For M&A particularly this is a good thing, companies can borrow large sums of money for a leveraged buy out. 

As the larger companies try not to stagnate, we may see a lot of their small competitors prime for the taking and a number of funds could benefit from this.  Mainly funds in the mid cap space will be best placed to see takeover bids as they have a more consistent growth rate.  Funds such as Schroder U.S Mid Cap and Royal London UK Equity Income could do well from this over the next few years.