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INVESTMENT COMMENT: Don't Let Squalls Deter Investors From Long-Run Gains - SVM

Colin McLean

SVM Asset Management

20 September 2013

Investors have learned that the most volatile shares are not necessarily those to avoid for long-term performance, and the outlook for UK stocks appears bright, argues Colin McLean, managing director, at UK-based SVM Asset Management.

In just five years, a remarkable stockmarket boom has emerged out of the despair of the banking crisis. Now, the nervous investors are the ones sitting on the sidelines with cash. Economic recovery in the UK and US is steadily building, with Europe finally joining in recent months. It may have taken unprecedented intervention by central banks, but the world economy is growing again, and corporate profits are up. In the depths of the banking crisis, few expected the bank sector to return to health. But, already that process is largely complete in the US, and progressing well in Britain.  

The extent and speed of the recovery has caught many investors by surprise. Those who have hidden in the apparent safety of defensive assets such as utilities, bonds and cash, may now have the confidence to move back into shares. With cash earning little, a move into risk assets could push shares still higher.

And institutional investors re-balancing global portfolios could drive this further. Some investment managers have been caught out by holding too much in emerging markets, with insufficient investment in major global businesses listed in the US, Europe or UK. This year, emerging markets have underperformed developed markets by 20 per cent - one of the worst relative performances in history. European shares, in particular, have been overlooked, as international investors chased Japan. That money could move to Europe if recovery continues. Too many investors have focused just on the negatives for Europe, and did not expect a scenario where Europe muddles through, until confidence eventually returns. 

It seems international investors have been betting on a breakdown of the eurozone or an industrial collapse. But, the doomsday scenario has been averted, and shares of major European companies now look cheap against their US counterparts. Not only is Europe at a discount on ratings, but profit margins have not yet matched the US recovery. There could be more mileage in returning to cyclicals in Europe, and Germany in particular. Certainly, some economic signals are mixed, but the improving confidence indicators are the key. Exports are also picking up. Opinion polls about a potential break-up of the eurozone matter much less than the hard economic data showing that Germany is growing again.  

The UK economy is currently performing even better than the eurozone. Despite the constraints on consumer spending, a number of retail and leisure businesses have re-focused and are being helped by lower competition. There are many UK consumer businesses with a specialisation or other competitive advantage that helps growth and stable profit margins. With low financing costs, these businesses can pay down debt, restructure or make acquisitions to enhance earnings. 2013 has seen a rapid turnaround in businesses that last year were highly indebted. 

British industrial businesses with global operations are also benefiting from the lower pound sterling, both through exports and translation of overseas earnings. There is also the prospect of potential merger activity within the sector. As sterling has depreciated over the past year, particularly against the dollar, UK companies have become relatively more attractive to overseas buyers. 

In contrast, mining shares may remain a risk, with concern that demand for metals could soften if growth in China and other emerging economies slows. China is likely to reorient its economy towards domestic consumption. This will mean that China needs less of the metals and commodities that were required for its infrastructure boom of the last five years. Growth in a number of emerging markets may slow as they raise interest rates to defend currencies. And, with cheaper energy sources, such as gas released by fracking, the major oil and gas businesses may also struggle. 

Overall, the global economy continues to grow, offering a favourable background for UK equities. More stimuli are likely for the UK economy, particularly in house-building.  In Europe, additional measures to address unemployment are also likely. Central Bank policy in both the UK and eurozone is now focused on maintaining low interest rates and assisting the bank sector.

The challenge of the past five years has been volatility, but it has proved right to stick with shares over the period. Sharp swings in sentiment encourage investors to run for cover but it is often the most volatile shares that are the best performers. Investors should not let anxiety stop them participating in the next leg of the recovery.