Asset allocation is at least as important as individual share selection. So where should you be putting your money? We give our monthly view on the major asset classes
Commodities: Tough times ahead
In 2009, the global economy shrank for the first time since World War II, and remains some way off its pre-crisis growth rate. “The system is firing on two cylinders,” as Ambrose Evans-Pritchard puts it in The Telegraph. While Europe is making a very slow recovery, the US economy will slow thanks to the latest fiscal stand-off in Congress, while China’s latest rebound is already fading, as the authorities clamp down on lending to pre-empt another surge of bad loans.
So the backdrop for industrial commodities remains poor. GDP growth in China, which accounts for 40% or so of global base metal demand, is set to slow from 7.5% this year to 7% next, says Capital Economics. In the next few years, Chinese growth will become less commodity-intensive as the government tries to promote consumption. On the supply side, production has increased after miners have rushed to boost it following years of underinvestment. The iron ore, copper, aluminium, zinc and nickel markets are all in or soon to be in surplus.
Nevertheless, mining stocks have recently fallen to cheap enough levels to have discounted the bearish near-term outlook. And we continue to like stocks that allow investors to bet on long-term upswings in the price of agricultural commodities, a result of rising populations and the scarcity of arable land. Farm equipment or fertiliser stocks are a better bet than the commodity futures themselves, which are highly volatile.
Equities: Buy cheap stocks
Since the US fiscal crisis was postponed yet again last month, equities have hit a new post-crisis high. Sure, the fundamentals don’t look great, as we pointed out above. Indeed, analysts’ third-quarter earnings forecasts for the S&P have been revised down in recent weeks.
But “forget fundamental analysis”, says Henny Sender in the FT. “It is all about liquidity.” The Federal Reserve’s money-printing, which will now probably continue at this pace until next spring, hasn’t done that much for the economy, but it has done wonders for asset prices. We would suggest sticking with markets that are cheap enough to have factored in any bumps ahead. That means Europe, notably Italy, and Japan.
Emerging equities have found their feet again too, now that global jitters have subsided. The medium-term outlook has clouded over now that the likes of China, India and Brazil have slowed, and US monetary policy is set to be tightened next year. Many countries have put off structural reforms that would help them grow faster. But one country that hasn’t is Mexico, while we also still like the Philippines and Vietnam. Brazil is also cheap enough to be reconsidered, despite the commodities decline.
Precious metals: Still the best insurance
Gold is on track for its first annual price drop in 13 years. Yet all the money being printed and injected into economies by various central banks is likely to eventually create inflation. That’s one reason to keep 5%–10% of your portfolio in gold. Ample scope for economic and geopolitical turbulence ahead also suggest that investors should hold gold as insurance.
Energy: Bet on natural gas
Natural gas is still more promising than oil, where declining Middle Eastern tension and the lacklustre global economy implies a flat or gently falling price. In the gas market, supply is abundant thanks to drilling techniques that have freed shale deposits, but demand should rise as more and more industries switch to this cheap, clean-burning fuel.
Cheap gas is also persuading some US firms that have outsourced production to bring operations back home. Companies that benefit from these trends, or provide services to gas explorers, are thus worth further investigation.
Property: A very British bubble
British mortgage approvals have climbed to a five-year high as government support for banks lowers mortgage rates. Government help for first-time buyers threatens to blow up the housing bubble again – prices are already 6% up on a year ago – even though the last one never really burst.
The ratio of house prices to average earnings never fell below the long-term average. In Germany, despite the Bundesbank worrying about an incipient bubble, property is still worth a look.
Bonds: Still too expensive
Government bonds have been through a 30-year bull market and are too pricey given the scope for a rise in inflation. Money-printing, which directly boosted government bond prices, has also made corporate bonds look too expensive, as investors desperate for yield have rushed into risky junk bonds.
This year, the yield on a global index of junk bonds fell to around 6%, a level that in normal times would be appropriate for some government debt. Keep away.