Comment: The review is done and the circus begins again

By BILL JAMIESON
Published on 23/07/2012 00:00

Last week, I completed what is euphemistically described as a “portfolio review”. This semi-annual reckoning of a ragbag of bonds, fixed interest holdings, gilts and equity funds that constitutes pension savings is normally followed by a period of deep depression and self-imposed isolation.

Such exercises bring to the fore the existential fear of savings evaporating long before one expires.

In the event, I had little to complain about and, indeed, much to occasion wonder. While underlying values have done little over the past 12 years, there was nothing like the immediate erosion I had every cause to fear given the combination of double-dip recession, eurozone crisis, broken banks and slowing global growth.

The valuation coincided with the FTSE 100 rising back above 5,700 points, an 11-week high. It has since slipped (naturally) but nevertheless the outstanding financial feature of this miserable summer has been a stock market rally that has driven share prices in the US to their highest levels since early May. Arguably, the biggest surprise of all is that the Eurofirst 300 index has advanced for a seventh straight week.

The big question posed by equity markets is thus not how poorly they have performed over time periods of five, ten and 15 years, but how resilient they have more
recently been. We have had no reason whatever to expect this.

A reasonable person, surveying the destabilising events in the eurozone, the approach of the dreaded “fiscal cliff” in America when spending cuts and tax rises automatically kick in, the growing concerns over poor second-quarter earnings, evidence of slowing growth in China and now a worrying sharp rise in soft commodity prices, would have emphatically concluded that the FTSE-100 should by rights now be between 15 and 25 per cent lower than it actually is. Either these adverse circumstances, singly or in combination, have been exaggerated, or we are heading for an awesome reckoning this autumn.

Thus, far from the portfolio review occasioning an urge to commit liquid funds, fear and indecision continue to hold sway. The portfolio is already defensively positioned. Why change this if I have cause to doubt whether there is going to be any improvement? Does not the newsflow continue to be deeply troubling? Indeed, should I not be selling down those equity funds and opting for a capital protection lockdown?

Mike Lenhoff, chief strategist at the stockbroker Brewin Dolphin, draws a quite different conclusion from this bearish backdrop.

Very little, he concedes, is going right. Prospects for global growth continue to be revised downward. His five-point list of worries includes the poor second-quarter earnings season in the US, the approaching “fiscal cliff” that could knock five per cent off US GDP, destabilising surges in crop prices, a new low for share values in China and, of course, the eurozone, where a brief break in crisis headlines ended last Friday with a surge in Spanish sovereign bond yields back above seven per cent.

Meanwhile, the German constitutional court delays a ruling on the constitutionality of the European Stability Mechanism well into September.

But, Lenhoff argues, it is precisely because of these worries that governments and central banks are likely to keep their feet near if not flat down on the monetary stimulus pedal. Further quantitative easing (QE) is likely in America when the Federal Reserve’s Open Markets Committee meets in September.

China’s premier has re-iterated statements on stepping up fine-tuning this year and that the authorities “must do everything possible” to expand jobs.
As for the eurozone, there are two grounds for some hope that the worst may not be the most likely out-turn.

The weakness of the euro, he writes, enhances the area’s international competitive position and is the best “growth pact” going. Peter Bofinger, one of Germany’s five “wise men”, said last week that the yields on Italian government debt are not justified by the country’s progress towards debt sustainability. That is a telling crack in a German position that has been adamant on the need for stricken governments in the eurozone to keep taking the austerity “medicine”.

Meanwhile, here in the UK more QE, a determined drive to boost bank borrowing through the “Finance for Lending Scheme”, and measures to boost infrastructure spending may well be augmented by further stimulus measures this autumn.

None of these developments guarantees a growth performance by equities in the coming months. However, European shares continue to offer a significant yield premium, both to bond markets and to other major equity markets. And there are many global companies catering for consumer staples that continue to offer attractive yields.

As always, the killer question in all “portfolio reviews” is where the cash realised from sales would be re-invested. For the moment it is a hard decision to forego a relatively “safe” 3.5 per cent yield on a well-diversified equity income fund in favour of next to nothing in government bonds or fixed interest. Every investment decision has an opportunity cost, and for those whose investments are already defensively positioned, that cost looks steep enough for now.