Central Investment: Market Watch January 2011 Market Direction: At


Central Investment: Market Watch January 2011

Market Direction: At a Glance

UK Equities:

Global Equities:

Big finish to 2010. FTSE All Share gains 7.0% in December; up 10.9% on the year.

7.6% gain in December. Massive 25.4% rise over the second half of 2010.

Leading Emerging Markets: China ends on a weak note. Brazil has a flat year, India a decent one.

UK Government Bonds:

US Government Bonds:

Gilts make modest gains in December after a sharp sell-off through November.

Prices stabilise after the big October / November set-back.

UK Corporate Bonds:



British Pound:

Follow a similar path to UK Gilts through December.

Prices continue to rise in December, closing-out a second-half surge.

Holds close to record levels, giving a stunning 28% gain for the year.

Ends the year slightly easier against the Dollar and the Euro.

US Dollar: The November rally fades. The Dollar ends 2010 up on the Euro, down on the Yen.

Equity Anxiety (VIX) Index: Measures the markets’ ‘fear’ of a big setback. A relaxed close to the year.


Market Report: A powerful close to 2010 for equities and commodities. Investor risk-appetite back in play in a big way as double-dip fears are set to the side. Bond prices weakening. Gold the star performer


Outlook: The balance of expert opinion strongly favours equities in 2011. Stocks are not expensive given company profits prospects, it is argued, and the alternatives of bonds, property or cash are not appealing. But there are quite a number of hurdles to cross.

Market Report

Always good to end the year on a high note and that is how most equity markets closed out December. The small set-back in November proved temporary and the FTSE Global All-Cap Index (an index of world markets) subsequently gained 7.6%, completing a stunning second-half that delivered 25.4%. This equity index was up

14.8% over the year.

The UK and American markets finished close to their 2010 highs. The UK FTSE All Share was up 10.9% over the twelve months, the US S&P 500 up 11.6%. Both indices had a 20% rally in the second half of the year.

German stocks made good gains over the final quarter, though other European markets found the going much tougher as government debt concerns came back to haunt us.

Interestingly, it was a mixed year for the big ‘emerging markets’. China had a poor 2010, for a variety of reasons. The main index there was down 14.5%. Brazil made no progress. India advanced by 17.4%. A volatile Russia was up 22.5%. Smaller emerging markets did well. But the numbers from China and Brazil serve to illustrate that strong economic growth does not inevitably translate into strong equity returns. Growth in western economies was much less vibrant, but the stock market gains there were remarkably robust given the big recovery we saw in 2009.

Commodity prices had a massive rally over the second half. Cereals, industrial metals and oil prices are all well ahead, rising on the global economic recovery story. Rising commodity prices carry an inflation warning, of course, and that has just served to reinforce the surge in the price of gold over the course of the year, up



Fixed income markets had a tougher time as 2010 drew to a close, though the returns over the year were still positive. Government bond prices weakened as interest yields rose from abnormally low levels. Investor perceptions of future inflation risks, debt risks and shifts in monetary policy suddenly began to alter through

October and November. Corporate bond prices felt the pressure too.

But all-in-all 2010 was a winner, after a rocky second quarter. Investor fears of double-dip recession in the west were set to the side. The focus is now on global economic recovery. The close to the year was a very strong one. The talk is of a ‘flying-start’ to 2011.

The US S & P 500 Equity Index

The Reuters CRB Commodity Index


Outlook for 2011

It looks good, at this point. A Sunday Times survey of ten leading dealing houses puts the average expected gain on the FTSE 100 index at 9.6% for 2011. There is a fairly high degree of conviction that equities stand to do well this year, perhaps very well. Big international stocks, resource and mining companies and those with emerging market exposure are tipped to top the list of performers.

This all sounds very comforting. A trade association poll of Investment Company managers saw 80% pick equities as the best performing asset class for 2011, far ahead of gold, bonds and property. Emerging

Markets and smaller ‘Frontier Markets’ alongside Asia and Japan are put forward as the best-performing regions.

Unit Trust managers are also generally pretty upbeat on equities. The team at Seven Investment

Management have a 12% gain in the FTSE 100 as their central view. Richard Buxton of Schroders, a closelyfollowed heavyweight in the industry, sees the UK as a very attractive market, because it is undervalued and has a global reach. He can see 20%-plus gains as a real possibility here.

When you read through views like these, it is easy to get carried away. But it is the assumptions behind the forecasts that count. To get big gains out of equities in 2011, for the third year in a row, much will have to go right.

The arguments in favour of equities stack up along the following lines :

The alternatives are not appealing. Cash gives you no reward. Government bonds are more likely to go down in value than up. Corporate bonds will consequently face a tougher time. There isn’t

• widespread value in property.

Equities will rise in value for as long as the economic news continues to surprise on the upside. Since the repair of the US economy is now underway, and since China will manage to keep the lid on a boiling economic kettle without having to switch off the gas, the odds are the news-flow will continue

• to improve and please.

Equities will rise in value as long as interest rates are ultra-low and governments lean in to support and stimulate asset markets rather than to cap them. We are quite a way from the point where

• government economic policy is taken down a gear or two in the US (though we can’t say the same about peripheral Europe). Here in the UK we have our own austerity programme to encounter. But the UK stock market hinges heavily on the global economy.

Equities will rise in value as long as they are inexpensive on historic valuation comparisons and big gains in profits can be generated by more modest increases in top-line sales revenues. Companies are generating very strong cash flows, and are set to go on the acquisition trail. That is generally another stock booster.

Equities will rise in value as long as their prospects are improving while investors don’t have enough

• of them. This is particularly evident in the US where over the past four years money has consistently been withdrawn from shares to be held in cash (paying nothing now) or invested in bonds (now on the turn). In other words, shares are going up and investors are short.

We are not going to make any attempt to deconstruct the pro-equity case. But it is as well to recognise some of the issues that could spoil the party in the coming year.

There are obvious geo-political risks in Asia. Beyond those, China and the US are increasingly ready to square-up to one another.

Inflation in China is an active threat. (In fact, food-price inflation is a widespread social threat in poorer countries.) This is something that has to be contained. But if you do it by ‘switching off’ the

• economy for a spell, you face a real backlash. And the commodity surge goes into reverse. And growth hopes plunge. This is very tricky.

Everything has to go right in the US. The housing market has to stabilise, and new jobs have to grow. Only then do Americans start to spend relatively freely once again. However the US housing


• market is in a terrible mess, with house prices still weakening and a huge overhang of unsold

(perhaps unsellable) homes. This will take years to work through.

Emerging Markets are ‘priced for perfection’ in some analysts’ eyes. They may be the future, but they are not necessarily cheap and some are being puffed-up by ‘hot money’ inflows that will reverse, at some stage down the line. We may have been seduced too readily by the story.

Greece and Ireland dominated Europe in 2010. The alarm bells on Eurozone sovereign debt burdens and bail-outs are going to sound again this year, for certain. The politicians really are wrestling with this one and the cunning plan is far from ready. Weak banks and weak national treasuries are combining to put the major part of the burden of ‘resolution’ on Germany and on Europe’s taxpayers.

One or both may simply say no. Years of austerity threaten Greece, Ireland, Portugal, Spain and others. The tensions could become acute.

Rising commodity prices are fine if you are a supplier, not so fine if you are a purchaser and they become unaffordable. It is conceivable that another surge in cereal, iron ore, copper and oil prices simply puts a stop to rising growth forecasts and turns the news-flow from one of welcome surprise to one of disappointment.

There is no way of knowing the actual outcome to all of this. Economic and market forecasts are simply forecasts. We do believe the environment is far from benign and that markets will be tested. They may survive, but they will be tested. Multi-asset portfolios that look to blend different asset class exposures, correlations and risks seem to be the most sensible approach as we go into 2011.


% change over period 1m 3m 6m 12m

AFI Aggressive Index


IMA Active Managed

AFI Balanced Index


IMA Balanced Managed

AFI Cautious Index


IMA Cautious Managed

IMA Absolute Return UK

FTSE All Share Total Return

FT Gilt 5-15 Year

50:50 FTSE All Share & Gilt 5-15 Year

Source: Financial Times. Trustnet, IMA