Investment Report
A new year and a new set of economic forecasts prompts us to reveal our investment predictions. Broadly, we think there are good opportunities for investment in UK companies with exposure to the US economy but we are avoiding consumer related, commodity and resources companies. This report provides the rationale behind our thinking.
There are many sectors in the UK market which stand at appealing valuations. The principal group of companies which we continue to favour are large (FTSE 350) UK businesses with exposure to North America. We believe many of these companies are undervalued due to investor pessimism about the plight of the dollar and fears about the outlook for the US Trade and Government Deficits.
We were surprised by the extent of the fall in the Dollar in 2004 but do not believe it will continue. This is because we believe speculation about how far the Dollar must fall in order to correct the Trade Deficit is exaggerated and because, at or below current levels, the Dollar will cause sufficient damage to growth prospects in other countries to prompt them to take action.
The increase in the Trade Deficit is a normal cyclical event. We believe it will fall during 2005 but, unless there is a change in the way in which it is calculated – valuing exports based on weight and imports based on price – it will continue to be overstated. We also expect the Bush administration to deliver on its promise to cut the Government Deficit in half in five years.
Another reason for preferring investment in companies with significant exposure to the US economy is the pro-business legislation that is being initiated by the Bush administration. We believe businesses with US exposure will be rewarded by increases in margins and improved stock market values at a time when UK and Western European companies are being constrained by costly red tape.
We are concerned about the effects of punitive regulations such as national insurance surcharges, pension obligations and social security legislation, on businesses throughout the main Western European economies. Western Europe will find it increasingly difficult to be a productive force against increased competition from India and China and the former satellite nations of the Soviet Union. It is our opinion that the US will remain the dominant world economy. We believe evidence of this can be seen in the performance of the UK and US stock markets in 2004: while the FTSE 100 index remains 45% below its all time high the Dow Jones index is only 8% below its all time high.
In the UK market we have an aversion to certain sectors. These include consumer related companies, commodities and resources.
The consumer has been hampered by rises in interest rates and the high oil price resulting in a slow down in consumer spending. This has had a detrimental impact on all areas of the market with exposure to the consumer and there have been a number of profit warnings. These businesses are simply repeating the mistake of the Information Technology companies in 2000 - creating an over supply in the market at a time when consumer demand is falling. We do not believe a fall in interest rates alone will correct this and think that we are likely to see a prolonged period of retrenchment.
In the commodity and resources sectors the fall in the value of the dollar and the emergence of China as a significant economic power created ideal conditions for growth. However, having attracted attention from the media and investors, we believe that the commodity cycle will turn leaving many investors disappointed. China is now a net exporter of steel and is starting to increase capacity at its own mines. It will not be long before economic fundamentals reassert themselves as additional capacity creates over supply.
These are the themes which guide our investment approach for the new year. If you would like to call us we would be delighted to discuss them in more detail.
We hope 2005 is a prosperous year for all.
December 2004
