April 2008 Newsetter...click here for full PDF version

Planning for a market downturn
As an investor, you understand that different asset classes and industry sectors are liable to turn against you from time to time. Despite equities' long-term potential, those of us who lived through the meltdown of the “dot-com” sector know that short-term, things are much less certain. Similarly, bonds - although viewed as medium to lower-risk investments, particularly when economic growth is on the wane, if you were part of last year’s crunch in credit markets you are probably suffering now. Many investors, faced with such downturns, tend to panic. They see only the short-term loss on their portfolio balance sheet and forget their reasons for investing. Sadly, this is the worst thing they can do – and it is why planning at the outset of any investment is worth every minute spent. If you know why you are investing and understand fully what risks are involved, market downturns should never have such an impact. Indeed, if you are far-sighted and have a degree of nerve, they can even be an opportunity. Such downturns can be wide-ranging and indiscriminate; meaning the share prices of high-quality  ompanies can suffer alongside lower-quality peers. This gives canny investors the opportunity to add to their portfolio at bargain prices. However, for most, the best strategy is simply to protect yourself whilst the market settles down. Nothing in a portfolio is more valuable than the time you spend achieving balance, diversification and cementing that long-term objective.

A core approach
A core investment is a holding (or series of holdings) designed to offer some predictability at the centre of your portfolio. The theory is that this majority segment remains constant for the longer-term, allowing you to follow medium-term or higher risk strategies with the balance. Dependent on your specific attitude to risk, the core is invested in what you would consider mainstream funds and assets, offering diversification and stable, lower-risk returns. This is then supplemented by a satellite strategy, where a smaller percentage of your portfolio focuses on more specialised areas, perhaps sector funds, smaller companies,overseas or even emerging market stocks.

Going for Gold
The price of gold has reached new highs recently, boosted by ongoing speculation over further cuts in US interest rates. Many investors view gold not only as a “safe haven” in times of stock-market turmoil, but also as a way to mitigate the effects of rising inflation and a weak US dollar. Growing fears of a recession in the US have led policymakers to reduce US interest rates in order to stimulate economic growth. However, these lower interest rates could help to stoke inflation and exacerbate the decline of the faltering US dollar. A weak dollar helps to drive the gold price higher: like oil, gold is priced in US dollars, so dollar weakness makes gold cheaper for investors buying in other currencies. The effects of increased demand for gold have been compounded by a growing shortage of supply. Electrical power cuts have halted production at some of South Africa’s most important mines when the South African government was forced to take the radical decision to ration electrical power. This, combined with fears that gold production could be halted for several weeks, helped to boost gold prices to their recent highs. A good diversifier Volatile market conditions, coupled with the fallout from the global credit crunch and growing fears over prospects for the global economy, have led many investors to add gold to their investment portfolios. However, gold does not have to be viewed purely as a safe haven; for many investors, it has become an important, long-term element within a diversified investment portfolio. It is vital to acknowledge that gold is not a risk-free investment: its price is volatile and can fluctuate rapidly. Nevertheless, gold’s low correlation with the equity market and bond market make it a useful means of diversification within an investment portfolio. Some investors favour owning gold directly, which can be bought in the shape of gold coins and bullion bars; others prefer to gain exposure via exchange-traded funds: investment funds that track the price of gold. A lower-risk approach – in relative terms – might be to opt for a diversified commodities or natural resources fund. This is still a high risk strategy in absolute terms but for the adventurous, would be a way of spreading an investment over a wider area than just gold.

Another credit crunch victim
Already-fragile investor sentiment has deteriorated further amid concerns that the problems faced by financial institutions are more widespread and serious than previously thought. Troubled US investment bank Bear Stearns has been bought by JP Morgan Chase for a fraction of its former value, despite increasing its initial US$2 a share offer fivefold, to US$10 a share. Bear Stearns had invested substantially in sub-prime mortgage instruments, but the value of these investments plunged following the collapse of the US housing market and the subsequent global credit crisis. Other banks became increasingly reluctant to invest in Bear Stearns and creditors began to call for their money, leading to a liquidity shortage that forced the bank to approach the US central bank for funds. Accordingly, the Federal Reserve has agreed to fund US$29 billion of Bear Stearns’ less liquid assets. If Bear Stearns had been allowed to go under, other financial institutions would have been hit with substantial losses that might have compromised their own solvency, a prospect that might have eventually undermined the entire financial system. Many investors had remained sceptical that the effects of the credit crisis were on the wane, and despite the aggressive actions of the Fed in cutting rates and feeding money into the system, investor confidence is likely to remain brittle for the time being.

UK Market update
The UK market looked like it might end the month with a brief rally, but the FTSE All Share slipped back on the last day of trading (Source: Financial Express Analytics). The view seemed to be that if things weren’t exactly getting better, then at least they weren’t getting any worse. All eyes were on the banking sector with many of the big names reporting full year results at the end of the month. In general, the news was good - there were further write-offs, but nothing to spook the market significantly. Northern Rock’s nationalisation provoked plenty of comment, but there was little reaction in the market.Management in the financial  sector sent out a confident signal with some aggressive dividend hikes. Barclays raised its dividend, HBOS didn’t let disappointing results hold it back and Royal Bank of Scotland was content with a relatively conservative rise. There were murmurings about the sustainability of the dividend hikes, given the ongoing problems in credit markets, but dividend cover looks reasonable at current earnings levels. But the news wasn’t universally good. Rentokil issued a profits warning, while Redrow saw a 35% fall for the full year. The macro picture, on the other hand, was relatively quiet and continued to give out mixed signals. The Bank of England kept rates on hold at 5.25% as expected. Inflation was marginally higher at 2.2%, from 2.1%, but the housing market remained gloomy. UK unemployment continued to fall and retail sales were unexpectedly up in January after a weak December.

US market update
After last month’s flurry of interest rate cuts, February proved to be a boring month for the US in comparison. Federal Reserve Chairman Ben Bernanke delivered a gloomy prognosis for the US economy, saying that the outlook was deteriorating and a weaker labour market could undermine consumer spending. He suggested towards the end of the month that the US may see some smaller regional banks fail. In a month where there was very little good news for US economists, consumer spending was the only area that held up. US retail sales rose in January after a weak December. However, this was not enough to improve sentiment as soaring oil prices and higher consumer prices stoked inflation and investors panicked about the Fed’s capacity to cut rates. Fourth quarter GDP slipped to 0.6%, down from 4.9% in the third quarter. Net exports remained surprisingly strong and without these, the economy would have contracted. Unemployment rose, but personal consumption expenditure continued to climb in the fourth quarter and remained high on the year. Bernanke's reassurance that he would continue to cut rates despite these inflationary pressures fell on deaf ears. All these problems had a significant effect on the dollar, which fell to new lows against the Euro and a three year low against the yen.

Is Japan improving?
After years of problems, the Japanese economy has recently benefited from a recovery period of sorts. It remains one of the three largest stock markets in the world and political change has helped to revitalise the domestic economy. There has also been significant restructuring by Japanese companies, which has produced benefits for investors. Still, Japanese investors have endured volatile performance in the past few years, but there have been stronger periods of progress and business confidence has generally improved. Many now believe the Japanese economy is on a better footing, which could finally translate into long-term stock market growth.

Global market update
The contrast between the buoyant Eastern economies and the lacklustre Western economies became even more marked during February. On the one side, the Chinese trade surplus rose 23% year on year to January while exports grew 26.7% and Indian industrial output also rose, up 7.6%. The high oil price boosted already-strong balance sheets in Russia and other oil producers. Japan delivered a surprise 3.7% rise in fourth quarter GDP on the back of strong exports to emerging markets. The Western economies showed an altogether different picture. In the US, GDP growth slowed from 4.9% in the third quarter to just 0.6% in the fourth quarter. Even then, it was sustained by a surprising growth in exports, without which GDP would have fallen. The Eurozone saw growth of just 0.4% in January, after three months of 0.8% growth. The Western economies remain in the grip of the banking crisis. Credit Suisse announced a further $2.8bn in losses. However, despite a UBS report suggesting a further $440bn of sub-prime losses remain in the system, banking management was in optimistic mood, with many of the major banks declaring double-digit rises in their dividend payouts. However, one black dog haunted both East and West – inflation. Chinese inflation hit an 11-year high at 7.1% on the back of higher food costs. Personal consumption expenditure in the US hit 3.7% to January 2008 and Eurozone inflation hit 3.2%. Markets were broadly flat over the month after the large falls in January*. They threatened a rally towards the end of the month, but gave up their gains on gloomy comments from Federal Reserve chairman Ben Bernanke in the last two trading days of the month. * Source: Financial Express Analytics, Indices over one month to 29 Feb 08.

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