Acombination of poor political leadership and weak economic growth finally proved too much for market sentiment. In eight trading days at the start of the month the FTSE 100 Index fell by 14%. In contrast, gilts went up by 2.2% despite general concerns about sovereign debt. Daily volatility was extreme with 500 point swings. Interestingly sentiment towards the UK remained positive. Gilts and sterling were seen as safe havens for international investors.
Relatively speaking stability ‘broke out’ in the middle of the month and by the end of August we were able to look back at equity market declines around the world of between 5%-10%, and strong performances by bond markets. For example the Gilt Index was up by 1.5%. Commodities were mixed with gold, + 12% and silver, + 5%. Industrial metals and oil, however, fell back on growing concerns about a double dip recession. Hedge fund results for the month will come through in few weeks time, but the early indications are that many still have too much equity risk and have suffered. Bright spots include macro-funds and trend following CTAs although not all made the right calls.
It does seem rather perverse that sovereign debt worries, including the S & P downgrade of US government debt, should lead to strong bond markets. Equally why should equities be regarded as high risk. Many well managed companies are already structured for modest economic growth at best or even a recession.
The UK equity market contains many companies with low debt paying good dividends. It is possible to construct a well balanced portfolio yielding 4.5% with the prospect of good dividend growth. Investors moving out of cash would benefit from a substantial pay rise.
Stock selection remains critical. All companies are suffering from higher energy and raw material costs. On the positive side labour costs are stable or declining. The key difference on a company by company basis is a combination of balance sheet strength and low exposure to economic growth. The final component is pricing power. Some have it and are able to protect margins whilst others do not. This will be the key to performance over the next 12 months. The gap between the winners and the losers will be substantial.
If August was a month characterised by politicians trying to make important decisions from the beach, September will provide us with a series of high profile events. Chairman of the Federal Reserve Ben Bernanke started the ball rolling in Jackson Hole, positioning President Obama’s Labor Day speech and the extended FOMC meeting later in the month. Also expect more news from Germany about the legality of the eurozone bailouts. The Bundestag vote is on the 29th September.
The investment agenda has definitively changed to the extent that now most are more concerned about lack of growth than excessive inflation. Higher interest rates are off the agenda and central banks discussions are now about the case for quantitative easing. Investors prepared to look behind the headlines will find good value but strong nerves will be required.
