Calculators

Looking for the catalyst

October 2008

At the moment, any sort of long-term recovery in equities looks a long way off. There have been significant one day gains, but most of these have come only after catastrophic falls. But stock markets look forward and are therefore likely to show a recovery before economic growth has resumed.

Theories as to the type of stocks that will lead the recovery are varied. Regionally, the US has historically been the first to recover. This has usually been a function of its more flexible economy and speedy policy response, but the kinds of problems it faces at the moment are unprecedented. It is likely to emerge with a huge budget deficit that will act as a headwind to economic growth for some time.

The countries likely to do best in the recovery phase are those with low debt, at both an individual, corporate and government level. This incorporates many of the emerging markets and the bigger economies in Europe (France and Germany), plus Japan, where fund managers now report widespread opportunities. In contrast, debt is likely to hold back recovery in the US, UK and parts of the eurozone, such as Ireland.

In terms of sectors, defensive stocks such as pharmaceuticals have proved resilient in the current climate, but are unlikely to be the top performers in any recovery phase. More economically sensitive stocks have traditionally done well at such times. For example, after a disastrous performance over the past 18 months, the UK Real Estate Investment Trust sector has outperformed the wider FTSE All-Share Index since the beginning of July.

Areas that have been particularly beaten up are also likely to show stronger performance. This could be the stronger stocks in unfavoured sectors, such as financials. It would be impossible to predict the outcome for the financial sector at the moment, but consolidation could ultimately create some new and powerful groups. Also, there are plenty of quality large stocks now trading on high yields, which bodes well for equity income funds, who will find they don’t have to take as much risk to meet yield targets.

There remains a big question mark over whether commodity stocks can continue to perform. Commodity prices have started to weaken and few expect them to revisit their levels at the start of this year for some time. In contrast, stocks such as airlines and rail companies may bounce back on waning commodity prices.

The opinions in this article are based on markets as at 6 October 08 and are subject to change. They do not constitute a recommendation to invest in any of the investments mentioned. Always seek professional advice.

Looking for the catalyst

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