Forecasting markets has to be one of the most thankless tasks there is.
Last week I wrote a review of my 2006 columns. I had, I said, got one big thing wrong — the timing of the end of the house-price boom, but had also got many things right.
I reminded you of about 20 stocks I have suggested over the year that have gone up by 20% or more and of a variety of markets and sectors I have been bullish on for some time. These include precious metals, hard and soft commodities, Germany and Japan.
All of them have performed perfectly respectably. However, I know the thing that most readers remember is not the right suggestions but the wrong ones.
With this in mind I usually try to start the year with one big forecast that seems almost guaranteed to be right. Last year, I said that I saw 2006 as the year when US house prices would start to fall and that the American consumer would finally lose confidence.
The first part of this prediction has happened, as house prices have been falling across the US for some months now. While it is still a bit early to be sure, it looks like the loss of consumer confidence will soon follow.
Christmas retail spending in the US looks like it will disappoint slightly this year. More dramatically, household borrowing as a proportion of household disposable income dropped 5.8% in the third quarter of 2006 from the same period a year earlier. That suggests consumers aren’t feeling confident about their finances. Given this outlook, I think I’ll keep “US consumers to lose confidence” as a forecast for this year. But I’ll add to it that the consequent slowdown in the US economy will be rather more severe than most people appear to expect.
Plunges in borrowing like the one we are currently seeing are almost always accompanied by sharp falls in spending and then in economic growth. The exception was 1987, when corporate spending rose enough to take up the slack.
Risks to stock markets in 2007
So what might this mean for stock markets? Well, clearly a consumption-driven slowdown in the US is not good news for the rest of us and that means there are serious risks for the markets this year.
However, there are other good drivers of global growth out there. The eurozone looks fine as Germany makes a comeback. The Japanese economy is still picking up and India and China both look like they can keep growing without big difficulties for a few years at least.
This doesn’t mean that a US slowdown won’t create huge volatility and a sense of crisis but it does mean that it may not affect the world quite as much as it would have five years ago.
A greater risk for global stock markets is a derivative or credit-related shock of some kind. There is a feeling in the market that we are long overdue such an event given the massive credit creation of the past few years.
The problem with this expectation is that it can’t be forecast. While we know it is increasingly likely that something nasty will happen we cannot even begin to say when or how, so we can’t plan for it. The best we can do therefore is make sure that we invest relatively safely.
UK stocks: good opportunities still around
The good news is that this is still quite easy. There are fabulous individual opportunities around in the UK stock market. The FTSE 100 is offering a dividend yield of 2.9% and has a prospective price/earnings ratio (p/e) for 2007 of 12.5. This means shares are expected to be worth 12.5 times company earnings.
This doesn’t mean that you should only buy the Footsie. If you look more closely you’ll see most UK stocks trade on more than 15 times. The average is cheap not because all the shares are cheap but because a few are very cheap indeed.
Look to those very cheap stocks and you will find great value: think BP (LON:BP), Shell (LON:RDSA), Glaxo Smith Kline (LON:GSK), which is yielding 4%, and possibly Unilever (LON:ULVR), which Steve Russell of Ruffer, an investment manager, points out could soon be a beneficiary of rising food prices.
It’s also worth wondering where the private-equity firms will be splashing their cash next. There’s lots of muttering in the market about there being a very large bid on the way. I suggested Vodafone (LON:VOD) as the target a few weeks ago and that’s still entirely possible.
If you are looking for other candidates think of any huge company that this time last year you couldn’t have imagined ever being a takeover target.
Then have a look at its valuations. If it’s cheap on any measure it’s probably a target now. I’d look for these plays in the energy sector in particular. Oil and gas are getting harder to find, with both listed and state-run groups having trouble replacing their reserves. Yet demand keeps rising. Chinese demand for oil is forecast to rise another 6% this year.
Private-equity companies are well aware of this fundamentally bullish picture. It makes sense for them to want to get in now while they can still borrow cheaply enough to make it relatively easy to do so.
Those looking for value in the UK might also consider very small stocks. While the FTSE 100 has risen 30% in the past two years, AIM, the market for fledgling companies, has barely budged. This suggests it may now offer good hunting grounds for stockpickers.
Marina Bond, manager of the Rathbone UK Smaller Companies fund, points out that AIM can look rather unattractive. But take out all the lossmakers and the market p/e is only about 14 times, despite the fact that these firms are forecast to grow by about 30% next year. They may not grow by 30%, of course, but even if it is only 20% that’s still good growth.
Next week, I’ll have a detailed look at a few smaller companies that I think might be good ones to hold this year.
Other stock markets to watch
Abroad I think I’d look to the same two markets I suggested last year — Japan and Germany. The Japanese market has had a boring year but all the bullish fundamentals I’ve discussed in this column over the past 12 months remain in place. I think it looks very good for this year.
Germany has had a much better year than many expected but there is still good reason to stay invested in stocks exposed to its property and consumer sectors. Bank lending is rising nicely, consumer confidence is up, unemployment is down and retailers are more upbeat than they have been for a good five years.
Those looking for property plays might consider shares in the AIM-listed property investment companies Speymill (SEA:SYG) and Puma Brandenburg (SEA:PUMA).
Finally, I’d suggest staying in precious metals. The falling dollar is good for all of them but for gold in particular. Also, stay invested in commodities because the reasons for doing so — tight supply and rising demand — haven’t changed.
First published in the Sunday Times 31/12/06