View from PIM “Lose Yourself'” Tom Becket, Chief Investment Officer December 2010 • The cracks have again been papered over During the last few weeks, many of the joys of 2010 have revisited us, ensuring that nerves are frayed and minds • Is Santa on his way again? tired heading towards the Christmas Break. Amongst the usual suspects, chaos in the European bond markets and • We are cautiously optimistic for 2011 the telegraphed announcement of QE2 has reignited an onslaught of volatility. However, in recent sessions, the • We have tactically increased equities clouds have lifted (and the snow has passed) allowing equity, credit and commodity markets to resume their healthy rises. This should be no surprise and we • But are now more balanced elsewhere positioned ourselves for such a move, recognising that December is often a good month for asset markets, as a “Santa Claus Rally” traditionally brings So, will it be a Happy New Year for investors? festive cheer to investors. The current optimism has Prospects for 2011 are incredibly difficult to predict and been reinvigorated by another stubborn show of political unfortunately Santa will not come every month. unity in Europe and further profligacy by the spendthrift However, our starting asset allocations are becoming US government, where instead of reining in their runaway somewhat easier to forecast, as many asset classes deficit, they have decided to reward the ultra-rich with an are now trading at what we believe are unsuitably rich extension of tax cuts. Merry Christmas indeed. valuations. Driven by our persistent fears of inflation in the years ahead, we are still avoiding interest rate The overpowering urges of most governments in the risk in our credit selections, favouring short developed world is still to pump their economies full of duration high yield credit over investment grade liquidity and encourage their consumers to spend the bonds and global index-linked bonds over economy back to full potential. Whilst in the short term conventional gilts. At times this year it has certainly this could be a potent driver behind economic growth been painful not to own “duration” risk, but we believe and corporate profits, further out the medicine could that our strategy is sound and is now being rewarded. cause some unwelcome side effects, with inflation Certainly, if UK gilt yields were to back up further in the chief concern. In fact, despite disinflation still lurking the coming months, we might actually start to add in the mature world, the emerging economies are already them back in to our portfolios, thereby increasing suffering from inflationary pulses, spurred by booming diversification further. A yield of close to 4% on 8 or commodity prices and abundant liquidity. In all-important 10 year issues would probably be enough to tempt us China, the central bank there is desperately trying to back in to the asset class. It is worth noting that despite apply the breaks on their economy, which has unnerved the recent improvement in economic data and our investors in the region. We believe that their actions are expectations for decent growth, there is still an outside totally justified and would actually encourage them to chance of a renewed economic slump in the quarters move more aggressively. ahead, conditions from which government bonds will benefit. In the last few weeks, we have also marginally We expect the global economy to perform moderately reduced credit risk throughout our portfolios, selling well in 2011, although once again the driving force of some of our positions that have gained strongly from growth will be the emerging nations. Economic leading yield compression this year and re-allocating to much indicators in many emerging nations have turned shorter dated positions. over recent months, but at present we can still envisage sound growth. Given the huge amount of On balance, our preferred asset class for next year is stimulus that has been hurled at the US economy, we equities. Reassuringly we can still find pockets of value have been revising up our expectations for growth in the in equity markets, despite the fantastic gains of the last world’s biggest economy as well. The UK is likely to fare 2 years. To us, the most attractive opportunities reside less well, as the government’s relative penchant for amongst the biggest global companies, with strong austerity will temper our economic potential. franchises and healthy balance sheets. Many companies have never been in a better financial 2010 has been an incredibly difficult year for asset state, with large amounts of cash on their balance allocators and investment strategists, but, as we sheets, which could lead to reasonable returns to currently stand, one which has proved ultimately shareholders, in the form of dividends and share rewarding for those who have embraced risk and buybacks. Mergers and acquisitions should also be a used volatility to their advantage. Looking forward, significant support for equity markets in 2011. We we are guardedly optimistic about the prospects believe that there will be good earnings growth next for investment returns in 2011, but acknowledge year, but again the engine will be vigorous consumptive that it is likely to be extremely hard going once powers of the emerging consumers. We still prefer to again. have a balanced equity exposure across global markets, including in the unloved Japanese market. In 2010, it has been easy to feel like both a genius It is possible that we might run with our maximum and a dunce within a matter of days, but sadly our equity weightings next year, although our focus will prognosis is for repeat bouts of schizophrenia in the be on “quality” companies in the developed world months ahead. Noticeably, during the year, Stanley markets, which our research suggests are trading at Druckenmiller, a legendary hedge fund manager who an almost unprecedented discount to emerging market led George Soros to force a devaluation of the British and lower quality companies. Pound in 1992, retired, arguing that the current conditions did not allow for sensible macroeconomic Of course the path forward for equities is unlikely to be investment strategies, underlining just how difficult a smooth, one-way street in 2011 and there are a and distorted conditions have become. Next year it number of “micro” concerns that are giving us plenty of will again be important to hold our nerve and stay food for thought. In particular, with profit margins in the course with investments we favour for the many industries already at extremely high levels, it is long term, but also be proactive in your hard to imagine a further expansion over the next year. investment strategy to ensure the best returns. With consumers still cautious about their job prospects and inflationary pressures being fuelled It is inherently dangerous to look out further than the by rising commodity prices, 2011 just doesn’t look immediate future, particularly with so many moving to us to be a year when companies can justify variables currently in play. However, we are still significant price rises. We might be adopting too concerned about the lasting impact of Quantitative cautious an attitude, but certainly our industry contacts Easing, the perils of money printing and ultra-loose are suggesting that a fog of uncertainty still lingers over monetary and fiscal policy. There is a real chance end demand in 2011. Therefore, with expectations now that beneath the many flimsy sticking plasters for earnings growth so high and following on from two that have again been applied to the debt-scarred years of good returns, there is certainly scope for global economy, wounds are festering and disappointment. We note that in the industrial sector, infections could once again afflict the patient in where margins might in particular be pressurised, many the years ahead. As Eminem once sang, you company insiders have already started to sell shares in shouldn’t “lose yourself in the music” that the central their own companies. We have therefore reduced our banks and governments around the world are exposure towards the more cyclical areas of markets, currently playing to keep financial markets in their including commodities, and increased our investments merry dance. At some point, we will have to pay the in consumer staples companies. price for the excesses of the last decade, despite the authorities’ ferocious attempts to postpone that pain Elsewhere in our portfolios we have continued to for another day. As Eminem went on to sing; “The reduce our commercial property exposure, where we clock's run out, time's up over. Snap back to reality, believe that the potential for capital returns is muted oh there goes gravity.” However, we don’t feel that and the income opportunities in the prime assets we the day of reckoning is now or in the near future. favour have mostly now been taken. Reducing our property exposure also is part of our move to increase liquidity in our strategies. Thomas Becket Chief Investment Officer 9th December 2010 The value of investments and the income from them can fall as well as rise. An investor may not get back the amount of money that he/she invests. Past performance is not a guide to future performance.
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