Why equities have further to fall before they eventually recover
Despite a strong August, investors must remain very cautious, warns Abigail Townsend
For the City’s dwindling band of optimists, August was a surprisingly good month. After hefty falls for most of the summer, the FTSE 100 rallied from lows of below 5,100 in early July to close at 5,362 yesterday, a 5.14 per cent gain over the month.
This bounce came despite precious little good news. To name but a few examples, housebuilder Taylor Wimpey, the country’s biggest, reported a £1.54bn half-year loss and warned conditions remained tough; yet another airline, this time Canadian low-cost carrier Zoom, started bankruptcy proceedings; and even the Chancellor, Alistair Darling, couldn’t be upbeat any longer, conceding that Britain was facing “arguably the worst” economic downturn for more than half a century.
Yet still the FTSE 100 rose, as traders gambled that the bear market had reached a bottom. Money that had been in defensive stocks like utilities switched into hither-to poorly performing retailers, banks and housebuilders.
False Dawn
It would be wrong to celebrate too soon, however. The summer rally was on thin trading volumes and the poor news flow is showing no sign of easing up. All of which suggests the market still has further to go.
Mark Dampier, head of research at Hargreaves Lansdown, the independent financial adviser, says, “I just think we have more down-cycle to come, and the market could revisit 5,000 or even below.” Most bear markets tend to last, on a broad average, around 18 months; this one has been going for just over 12, and the FTSE 100, around 12 per cent lower over the year, is still trading near to all-time record highs.
“This is a much-need correction,” says Richard Ramyar, head of UK research at Lipper, the data provider. “What’s happening now has to happen if this market is to continue going to the moon.” He believes that a bottom could come by the end of this year, though adds the caveat: “It would then need a run of another six months to really confirm that we’re getting back into something healthy.” Little wonder then that banks and housebuilders – which saw prices jump last month – are still viewed by many as risky bets for investors, with potentially more downside to come.
Investors would be sensible to be cautious. Says John Chatfield-Roberts, head of the independent funds team at Jupiter Asset Management: “We’re trying to buy people who have been around a bit, who are quite defensive investors, who have the capacity for looking for downside risk as well as upside – someone who’s a realist.”
Bearish Managers
This sort of manager includes Neil Woodford, who runs the Invesco Perpetual Income fund, Richard Buxton, with the Schroder UK Alpha Plus fund, and Philip Gibbs, manager of Jupiter Financial Opportunity. “He’s very bearish, most of that fund is in cash,” says Dampier of Gibbs. “But he has called the market a lot of times over the last ten, 15 years and he’s been pretty close to being right most of the time.”
On a medium-to-long term basis, there is more optimism. The FTSE 100 is expected to regain momentum thanks in part to the global commodity and oil markets.
With supply tight and demand from economies like China and India high, commodity prices have surged in recent years, fuelling much of the FTSE 100’s performance. Blue chip mining and oil companies have had consecutive years of record profits. These companies are now some of the biggest in the top flight.
Commodity markets have eased off in recent months, some sharply, while crude has retreated sharply from its record high of $145 a barrel, reached in July. But few believe this is a long-term trend. “If you simply plotted a line you would see it’s a blip,” points out Lipper’s Ramyar. “There’s fundamental demand in terms of commodity consumption.”
Share prices of miners will further benefit from a flurry of deals across the sector. BHP Billiton is aggressively pursuing fellow blue chip Rio Tinto, for instance, while Anglo-Swiss Xstrata has tabled a $10bn hostile bid for platinum producer Lonmin.
Energy Products
Chatfeild-Roberts, meanwhile, believes the price of crude has further to fall in the short-term and could even test the symbolic $100 level once again. “But on a five-year view,” he adds, “once the world’s economy has recovered, I’m sure it will go up.”
Dedicated commodity and energy products include the £1.9bn JPMorgan Natural Resources fund, the BlackRock Gold and General fund, First State Global Resources Fund and Investec Global Energy fund.
With conditions uncertain in the short-term, however, dedicated funds like these are often best used in conjunction with broader products such as funds of funds. They are by their very nature diverse products holding a range of assets run by a variety of managers. Chatfeild-Roberts, whose funds of funds include the £1.2bn Jupiter Merlin Income Portfolio, says that while some have lost money recently, they have still outperformed the wider market. Other funds of funds include New Star’s Active Portfolio.
Exchange-traded funds (ETFs), meanwhile, give investors a cheap, liquid way to track the FTSE 100. Examples of these opened-ended investment funds include iShares FTSE 100, Lyxor FTSE 100 and db xtrackers FTSE 100. ETFs issue shares, allowing investors to buy and sell them as easily as they would a listed company. So they have the liquidity of a share while retaining the diversity of a unit trust. They also benefit from low fees and being stamp duty exempt.
Calling the bottom of a market is always tough. What is certain, however, is that summer is coming to an end and the August optimists are in danger of being proven wrong.
The FTSE 100 is going to get worse before it gets better, and investors would do well to prepare now for what could be a turbulent end to the year.