The art of investing

By MOIN SIDDIQI

The task of professional fund manager is to anticipate future market trends and make rational investment decisions to realise both capital growth and steady earnings streams for clients. Selecting the right combination of stocks is a sign of a competent asset manager.

However, as often in life, being in the right place and at the right time are the key to success, and this principle applies equally to a successful investment strategy. The question is, is it really possible to time an optimum entry into stocks within an increasingly globalised economy? It is certainly a formidable challenge for fund managers to ?fine-tune’ their asset allocation to provide sustainable good value during different macro economic cycles.

Stock markets are effective channels for re-cycling investor savings over a number of years, with the aim of providing long-term capital growth. But higher exposures to equities are mainly suitable only for liquidity-rich investors, able to withstand short-term losses.

Despite the ongoing volatility, equities have historically out-performed safe-haven assets like bonds and cash. This explains why so many institutional investors, including pensions and insurance companies are heavily exposed to global equities.

Market movers

The more risk-averse investor, holding an excessively large cash portfolio, usually earns paltry returns. Professor Burton Malkiel of Princeton University and author of A Random Walk Down Wall Street writes: ?An investor who frequently carries a large cash position to avoid periods of market decline is very likely to be out of the market during some periods when it rallies smartly.?

Generally, share prices are driven, at least in part, by basic fundamentals like growth prospects in both domestic and overseas markets, corporate earnings (the underlying returns of the industry), the direction of interest rates, and currencies. Economic indicators, the psychology of investment and speculations, as well as political developments can also move the markets.

When an economy is in a ?robust growth’ phase, the main beneficiaries are new economy stocks (telecoms, media, technology), leisure entertainment & hotels, automotives, and real estate as the earnings of these respective sectors are reliant on higher consumer purchasing power, i.e. rising private wealth in the developed world.

At the other extreme of economic cycle, during a period of economic slow-down as in the US currently, defensive sectors such as pharmaceuticals, health-care, tobacco, food manufacturing, consumer staples and beverages, utilities (electricity, gas distribution and water), insurance and life assurance offer safer forms of equity investments because these stocks earnings do not fall as steeply during an economic downturn. In essence, household expenditures on these essential items remains largely stable during weaker economic activities, whereas the stocks of automobiles and luxury household goods are hit quite hard from a sluggish economy.

Cyclical stocks such as resources (mining, oil & gas), basis industries (construction & building materials), chemicals, capital goods/engineering and semi-conductors tend to out-perform defensive groups as the economy improves. During a climate of gradually improving growth prospects, interest-sensitive stocks like banks and investment companies usually perform strongly because of low and declining interest rates.

During times of a full-blown global recession, with plunging stock markets, cash positions are advisable such as money market instruments like US dollar Certificates of Deposit and major international bank time deposits; and safe-haven fixed investment such as US Treasury bonds, short-term T-bills, or UK Gilts. These assets provide both liquidity and a 100% money-back guarantee.

Most central banks of the developing countries have invested the bulk of their foreign exchange reserves into US and European fixed-income markets.

Strategy for today

An interesting question is which particular investment strategy suits today’s global economic conditions?

Markets are adjusting to a period of subdued world economic growth at 3% or less this year, but so far there are no concrete signs of recessionary conditions as happened in 1981-82 and 1990-91. Jacob Freckle, chief economist at the International Monetary Fund says: ?We are not talking about a global recession, we are talking about a slow-down in non-sustainable growth.?

Conservative strategy

If potential investors are taking on a short-term position, say for less than a year, the ?old-economy’ stocks, mostly defensives, seem to offer reasonable stability of earnings growth. Major investment banks like Merrill Lynch and Goldman Sachs have advised their clients to pursue a more conservative investment strategy this year. The former prefers defensives such as tobacco, oils, infotech hardware, and financials - while a recent Goldman Sachs’ report comments: ?Slower than expected growth points to defensives: We expect beverages, food retailers, and utilities to out-perform if the major economic shock in 2001 is slower than expected growth.?

Goldman advises investors to seek security in these areas while avoiding the ?highly exposed’ sectors such as automotives, chemicals and luxury goods.

Most investment analysts remain extremely wary of new exposures in new economy stocks, following the burst of the US technology bubble. Even the industry’s heavyweights - Microsoft, Dell, IBM, Intel, and Siemens - have recently suffered earnings downgrades leading to steep falls in their share prices.

The time to buy?

The present weaknesses in the world’s markets could be viewed as better-value opportunity for global investors to reposition their portfolios and buy cheaply, especially into some under-valued tech stocks - if investors are willing to take more risk and believe that a global economic revival in 2002-03 is likely.

Given that governments of the industrialised world will introduce policies to stimulate their economies, leading to easier liquidity conditions, then share prices should rally next year. In such a climate, cyclical and new economy sectors would offer better earnings prospects than purely defensive stocks. Historically, most defensive stocks have provided lower long-term returns.

For this year at least, the earnings’ expectations for most global blue-chips are generally subdued, therefore investors should not anticipate superior returns on their savings in Western stock markets. However, major emerging markets may offer more attractive returns on capital, estimated by some analysts at 15-20% this year, but there are always unforeseen risks to contend with.

Back to the top
Contents