It's time to think about the future

Dec 9 2009 by Andrew Miller, The Journal

AS what has been one of the most volatile years for equity markets in living memory draws to a close, it is time to start thinking about the likely direction that markets will take as we enter the next stage of the recovery.

As we have discussed in this column before, we are confident that equities can continue to make progress from current levels.

Furthermore, when looking at estimated total returns, equities appear to offer better risk-adjusted returns than government bonds, corporate credit, or cash.

However, as in any recovery, initial euphoria generally recedes and attention turns to fundamentals; recent evidence from the last few months would seem to support this view.

While most of the major equity markets have continued to hit new highs for the year, emerging markets are finding it increasingly hard to differentiate themselves from the developed markets, unlike earlier in the year when they outperformed handsomely.

The best performing market in the month of November, by quite some margin, was the US – traditionally one of the most “defensive” markets.

Over the next couple of quarters, we believe a focus on markets and sectors that offer attractive valuations, with sustainable and less volatile earnings growth, should increasingly reward investors.

Consequently, at a country level, we still favour developed markets relative to emerging, and within sectors we continue to recommend rotating away from the economically-sensitive recovery sectors. In essence, equities are still positioned to make decent progress, but the drivers will change.

Bearing all this in mind, we have made a few more changes to our sector recommendations this month; our aim is to reduce exposure to the initial recovery sectors (mining, financials, and consumer discretionary, essentially) and focus more on reasonably valued and less volatile growth.

Specifically, we are downgrading the materials and financials sectors globally following strong gains. Both sectors have led the market higher since the March lows; this has left their valuations looking expensive.

But valuation is only one factor: we are also beginning to see sentiment slip as earnings momentum, and very recent price action, has moved away from these previous market leaders.

To fund these downgrades, we are upgrading both consumer staples and utilities, both of which have lagged the recovery, but which offer attractive valuations.

Andrew Miller, regional office head, Barclays Wealth