Despite turbulent events in 2011, stock markets ended the year with mixed fortunes. In the US the S&P 500 was up 0.74%, the UK’s leading FTSE 100 index was down 5.55% and unsurprisingly the DJ Euro Stoxx Index performed worst, down just over 18%. In such an environment, fixed interest funds stood out as the top performers, with the largest gains posted by Index Linked Bonds. The year to date has continued the uncertain trend, with the first and second quarters generating contrasting market conditions. Improving consumer and business confidence, in addition to policy stimulus, buoyed investors in the first quarter, with the US particularly favoured due to its perceived superior growth prospects for the remainder of 2012, while emerging markets also benefitted from greater risk appetite, posting 11% gains that outstripped almost every other region or asset class. However, progression into the second quarter brought with it the return to prominence of the sovereign debt problems in Europe, with investor focus very much concentrating on how viable Spanish finances are in their current form.
Greece is becoming increasingly alienated within the Eurozone bloc, with many observers suggesting its only option is to leave the single currency, especially given Germany’s reluctance to finance additional rescue packages. Such European problems coupled with weakening US and Chinese economies as well as high oil prices placed sentiment firmly in negative territory throughout April and into early May, although some respite was provided by a near 20% fall in the oil price during the remainder of May. In terms of asset performance, equities have navigated conflicting economic sentiment relatively well, although this is by no means universal, with the strong US market far outperforming its rather anemic European, UK and Emerging Market counterparts. Fixed interest funds have again, unsurprisingly, remained in favour, although index linked have cooled a little due to receding inflationary concerns. In the alternatives space, property is the second best performer for 2012 so far, while hedge funds are also performing well.
As in our view the economic backdrop is likely to continue to remain uncertain until at least the latter part of the summer, we believe we should maintain the cautious stance that we have held for some time. While markets have been encouraged by the European Central Bank’s (ECB) willingness to support Spain should it need financial assistance – an increasingly likely outcome – doubts as to the strength of the driver of global economic growth, namely China, are becoming more commonplace. In response, Chinese authorities have reduced interest rates and delayed bank capital reforms in the hope of propping up its declining rate of economic growth, although of course the results of such policy action are yet to materialise. The possibility of Greece leaving the Euro is another cause for concern as the fallout from any partial breakup of the Eurozone is an unknown quantity, while a stable oil price as is the case now is by no means assured to continue over the coming months principally due to ongoing tensions in Iran leading to the potential for supply shortages.
While cautious in our view, we still prefer equity funds focused on quality dividend paying companies to bonds, which we believe offer very little value as a consequence of QE and forced purchases by banks. We are most positive on prospects for emerging equity where weightings have increased, due to attractive valuations, lower debt burdens than the Western regions and greater scope for governments to ease monetary policy. Across all asset classes we are aware that correlations have been increasing and as such will look to maintain the cash holdings within the portfolios that have been gradually built up of late. Our stance on Absolute Return funds remains positive albeit with an increasing focus on lower risk strategies that have lower correlations to traditional asset classes, thus providing greater diversification benefits. The asset protection mode of our portfolios which has proved effective throughout a very challenging year is set to continue.