Markets had a torrid time in 2008, so it is easy to get sucked into the doom and gloom and fall into the classic trap of building a portfolio for 2009 that would have performed well in 2008. To avoid this, I have attempted to identify where the market’s buying appetite will be three to six months from now.
The economic backdrop will undoubtedly be difficult for some time to come. Banks, for example, will continue to favour preservation of their capital over new lending. This means it is difficult to see a quick end to current problems despite the huge monetary, and prospective fiscal, stimuli being employed in the UK and elsewhere. Indeed, my concern is that in attempting to provide such vast levels of support, governments will in the process prop up some inefficient, over-indebted and poorly run companies, not to mention countless sickly personal balance sheets.
As a result, although the downturn may end up being shallower than may otherwise have been the case, it will last a lot longer. My gut feeling is that a shorter, sharper downturn to clear out some of our economic excesses would have been preferable in the longer term. So at this point we should be aiming the bulk of the stimulus at those companies that are prepared to buy some of the most-distressed assets from the walking wounded.
At significant turning points in markets it is usually very unfashionable sectors that generate outperformance in the years that follow, often from an initial position of severe weakness. Many fund managers shy away from looking at such sectors even though their valuation metrics suggest it’s worth doing so. For now, the downtrodden sectors include retailers, some areas of leisure, specialist financials and possibly even house-builders. Having said this, it is also clear that, given the likely severity of the downturn we are facing, there will be casualties. As such I have been keen to retain the core of my portfolio in financially sound, well-managed, cash-generative businesses that have strong industrial fundamentals. In a bid to move the emphasis away from the defensive tilt that has proved successful over the past year and increase exposure to some of the areas suggested above, I am seeking companies that will emerge from the currrent malaise in a far stronger competitive position, either due to their competitors struggling (which gives them scope to grab market share), or because their financial strength gives them the ability to pick up valuable assets at distressed prices. I am also keen to look for the positive in every bit of bad news that breaks. An example of this would be the problems surrounding the US insurer AIG. These issues could potentially be great news for the Lloyds of London insurers. Given that significant amounts of capacity are likely to be withdrawn from insurance markets, the outlook for premiums has improved markedly in recent months.
Consequently, I have increased my exposure to the sector through bigger holdings in Amlin (LON:AML) and Brit (LON:BRE). I also hold Thomas Cook (LON:TCG) and TUI Travel (LON:TT), which have benefited from the collapse of the travel company XL in September. Similarly, the distress currently being experienced by many airlines may well prove to be a great opportunity for the likes of Easyjet (LON:EZJ), which remains well financed with a strong management team and an industry-leading low-cost base.
Overall, it is easy to get stuck in a rut given the gloom that surrounds us at present, but it’s tough times such as these that can produce the best investment opportunities. One must tread very carefully, but going against the flow may prove highly rewarding.
• Leigh Himsworth is manager of the Royal London UK Strategic Growth Trust.