Bill Jamieson: On the defensive remains a sensible place to be

IF IT seems too good to be true, you’ve probably bought the wrong product or missed the warning notices. On the stock market this is especially true – with the added caveat that the stronger the sensation of unexpected gain, the great the danger of setback ahead.

Since the start of the year, stock markets have surged. In America, the S&P 500 broke above 1,400 for the first time last week since June 2008. In Japan, a market on which investors have long despaired, the Nikkei has hit a ten-month high.

Even in continental Europe, struck down for two years by an intensifying sovereign debt crisis, the Eurofirst 300 was pushed higher by banking shares to hit an eight-month high.

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Nor has the UK lagged. Gains in those two most investor-averse sectors of 2011, banks and retailers, helped the FTSE 100 index to finish last week at its highest level since last July. It is now back within a whisker of 6,000 points.

There’s nothing like a powerful rally like this to encourage investors to don the buying boots and get clicking on those financial websites. There has certainly been a strong case on dividend grounds for buying and holding equities in recent years. And the constant advice of this column has been to hug those defensive, income-orientated sectors and funds. Capita Registrars calculates that retail investors have received about £38 billion in dividends since 2007 despite a flat stock market overall, and that they can look forward to a record £8.5bn in dividends this year, up £500 million in 2011.

But can we really look forward to this rally continuing at this pace? I would say investors need to proceed cautiously, for three reasons.

First, this rally has been made possible in the main by an unprecedented degree of monetary loosening by central banks. Asset prices have been a beneficiary of quantitative easing programmes or their near equivalents in America and the eurozone. This support cannot continue indefinitely. Indeed, recent hints by the US Federal Reserve that it may not continue with further bouts of monetary easing this summer caused a sharp pull-back in government bonds and the gold price – down some 13 per cent since last September.

Second, the overall imperative across Western economies is debt and deficit reduction – a message that will be remorselessly hammered home in Chancellor George Osborne’s Budget on Wednesday. The excited chatter over tax giveaways needs to be tempered by an appreciation that we are still nearer the start of the “austerity” programme than the end and that the task of meeting the deficit reduction targets for future years is set to become progressively harder, no matter that government borrowing for the year just ending is likely to undershoot forecasts by between £3bn and £7bn.

And third, economic recovery worldwide, while looking better than most had hoped a couple of months ago, will still be very slow by historical standards. In the UK, we will do well to achieve growth of just 1 per cent this year – the current forecast is for 0.7 per cent – largely due to a continuing squeeze on household budgets and the priority that households are giving to borrowing reduction – a very necessary correction.

Investors should stick with those dividend-paying defensives for now, but looking ahead, they might consider cautiously feeding in new money into smaller company trusts. This sector is likely to benefit from further budget measures to stimulate bank lending and other sources of finance for the smaller firms sector.

Setting the Standard for gains in tough times

Shares in Standard Life have enjoyed a markedly strong rally, notwithstanding a slowdown in UK profits. The shares have surged 35 per cent in the past three months and now stand at 251p – comfortably above the 230p price at which the shares started trading six years ago.

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A gain of 21p hardly seems much of a reward for loyal investors over those six years. But these have been years of historic turbulence for the financial sector, UK personal savings have come under intense pressure and it has become ever more difficult to persuade households of the merits of long-term pension saving – even before any ill-considered Budget tinkering with higher tax reliefs and thresholds on Wednesday.

But the bigger reward has of course, been in the form of dividends. Standard Life has consistently raised the dividend payout in recent years and a further 6 per cent rise has just been announced.

The group’s share rating looks unduly mean given this consistency of improvement. But life assurance accounts are not the easiest to understand and the group is operating in a sector that has been highly susceptible to crisis in recent years.

However, on the assumption that common sense prevails on Wednesday, the shares – currently yielding 5.8 per cent – remain a strong buy for income conscious investors.

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