Introduction
Despite several wobbles, the world’s stock markets have shown great resilience. Such strength should not be a surprise given the favourable economic conditions and encouraging corporate earnings announcements. Interest rates and inflation globally are at historically low levels, companies are reporting good results and many are sitting on large cash balances and confidence among investors is growing following several years of good returns.
Mega Caps
One area of the UK stock market that has provided stability in the rocky markets and still looks genuinely cheap is the mega cap stocks, represented by a handful of the largest companies in the FTSE 100. These companies have been neglected by investors in favour of the FTSE 250 medium sized companies more likely to be involved in merger and acquisition activity. However, at their current low valuations and with the potential to beat earnings expectations, we believe the mega caps may find themselves fending off unwanted suitors.
Aim
We have also been looking at AIM, home to the smallest listed companies, as we adhere to our policy of looking at unloved areas of the stock market. The AIM market suffered two years of disappointing returns in 2005 and 2006 due to a number of high profile collapses in the gaming and resources sectors. Both the AIM index and the mega caps significantly underperformed the FTSE 250 in this period. However, the significant inflows of cash into the FTSE 250 has made valuations look expensive in our opinion whereas AIM listed companies and the mega caps look much more attractive on valuation grounds. We believe now is the time to make the switch out of the FTSE 250 and into AIM and the mega caps.
US
Overseas, we believe the US presents some interesting investment opportunities. The performance of its stock markets has been hindered due to adverse sentiment focused on various media sound bites: ‘twin deficits’, seventeen consecutive ‘interest rate rises’, the ‘weak dollar’ and ‘subprime lending’. Everyone is well versed on the negatives but perhaps now is the time to take a closer look at the opportunities the negative sentiment has presented. US companies have quietly been producing good returns, a strong export market is a positive for the trade deficit and the increased tax take from corporates has led to a fall in the budget deficit. We believe we are at or near the peak in the interest rate cycle and that the dollar is unlikely to fall further against other major currencies. Sub prime lending is a concern but we are avoiding property related investments globally. Most important, however, is the major positive that valuations are attractive due to the fact that company share prices have not risen in line with the increase in earnings.
Premium Brands
A catalyst for improvement in the US stock market may be the recent memorandum of understanding signed by Chinese government officials which takes effect on July 5th. The memorandum allows domestic and institutional investors to invest in overseas markets includng the US, Hong Kong and Japan and places no quotas or restrictions on the amount of money that can be invested. We expect this memorandum to release significant liquidity which will find its way into the world’s major stock markets. Companies which make or own premium brand goods are likely to be beneficiaries of the flood of money into the stock markets as Asian investors mimic their discretionary aspirational spending in stock market investments. We are therefore looking at global funds invested in premium brands.
30 June 2007
