While the rise of global equity markets over the past year has been extraordinary, it is good to put it into context.
At the start of 2008 we had braced ourselves for a tougher environment for investing – but there was no way we could anticipate anything like the events that actually unfolded.
The Schroder UK Alpha Plus fund was not positioned in defensive sectors, but remained exposed to cyclical areas including mining companies and consumer names. The share prices of these types of businesses plummeted – irrespective of long-term prospects or financial stability – as investors became increasingly convinced of economic Armageddon.
We felt the market’s reaction was overdone and increased our exposure to these names – a decision which has been rewarded over the past 12 months with exceptionally strong returns.
Mining shares are a good example here. Share prices across the sector were savaged in 2008, falling around 80% from the peak. Having reduced exposure here when shares were buoyed by the strong oil price, we did not panic as we believed now and then that we are witnessing a multi-year bull run in commodities. Holdings such as Xstrata have subsequently staged a dramatic recovery and have been amongst the strongest contributors to performance over the past 12 months.
2008 was also a terrible time for banks, highlighted by the fall of Lehman Brothers and revelations of ‘toxic debts’ on bank balance sheets around the world, the market began to price-in complete collapse of the global banking system.
The portfolio at that time was exposed to a number of high profile UK banking names and this did create a serious drag on returns. However, I hung on to names such as Barclays and Lloyds as I could not see the UK Government allowing these institutions to fail or pass entirely into Government ownership – which, of course, did not occur. Like our holdings among the miners, banks have staged a terrific recovery from their lows.
I should say, however, I do not think this is the end of the story for the banks; further gains are still achievable as we work our way through the bad debt cycle and greater clarity emerges on regulation and capital requirements.
We continue to expect a much more uneven pattern of returns in 2010 than we saw in 2009, with the FTSE 100 potentially grinding up to 6,000 – but maybe dropping below 5,000 on the way. Indeed, despite continued signs of recovery and strong corporate news, there are still many factors that could trigger short-term bouts of nervousness amongst equity investors.
Worries about the sustainability of the recovery are particularly prevalent, along with concerns about tightening in China and worries about the scale of fiscal deficits in Europe. UK investors are also weighing up the prospect of a hung parliament and the likelihood of a post-election austerity budget given the ‘doomsday’ scenario that bond yields leap in the face of insufficient fiscal tightening. It is our belief that fiscal action, notably in the UK, will be sufficient to reassure bond markets and keep yields from undermining equities, but we remain convinced the general uncertainty will keep share prices volatile for some months yet.
Richard Buxton is head of UK equities at Schroders and runs the Schroder UK Alpha Plus fund.
