The economic environment is still laden with uncertainty and volatility, words you will hear very often. With this backdrop, I shall be keeping my portfolio defensively positioned. The stock market is presently locked in a zigzag motion, driven by renewed anxiety over sovereign debt, political events and central banks stimulus. I believe the central theme this year is uncertainty and I expect to see significant market oscillations going forward.
Income producing assets
In this environment, the best reward for investors is in the form of rising dividends, from dependable global companies whose businesses are not reliant on the fickleness of the economic cycle. Whatever the economic climate, these well-run businesses can continue to advance their dividends and earnings over time.
Investor’s uncomfortable with stock picking can alternatively buy a stake in a diversified portfolio of dividend paying shares through an equity income fund. One such investment I hold in my portfolio is the ‘City of London Investment Trust’. This fund has an impeccable record, raising dividends for a record 45 consecutive years. The fund has an impressive net dividend yield of 4.5% (against 3.7% for the FTSE 100) and one of the lowest ‘Total Expense Ratios’ in the industry, at 0.44%.
The Federal Reserve has promised to keep interest rates low until unemployment hits 6.5%, incoming governor Market Carney has hinted at targeting growth and abolishing the inflation target, and Pressure for looser monetary policy in Japan will have two ramifications.
Firstly, it will result in a protracted period of low interests; this will bolster the appeal for higher yielding assets (shares, emerging market bonds and commodities). Negative rates on government bonds are a direct result of central banks bond purchasing programmes, with many commentators predicting a bubble in the bond market. An indication of this is that UK pension funds now hold more bonds than equities since the 1950’s. An end to this bubble may benefit its closest substitute – Equity income investments.
Secondly, aggressive monetary policy and its side-effect currency debasement may fuel inflation over the long-term. I believe this will benefit inflation-proof equities and commodities.
I see utilities, who have the ability to price their services above inflation as the prime beneficiary of Inflation, I see value in both electricity and water utilities. The economic backdrop of low interest rates and elevated inflation is tailor made for water utilities, hence my investment in Pennon Group (LSE: PNN). However, the firm is unique in that it’s the only utility to own a non-regulated company called Viridor, its waste management business. Falling prices of its recycling materials hit profits and triggered a 15% plunge in its share price, it presently yields 4.4% and I still believe it’s an excellent long-term investment.
On a valuation basis, the FTSE 100 trades at 12 times earnings and yields a decent 3.7%. Europe also looks tremendously cheap on a CAPE basis. Given the meagre returns on bonds and cash, equities could be the chief outperforming asset class this year.
Overall my outlook for 2013 is optimistic. I concur with Richard Jeffrey, the Chief Investment Officer of Cazenove Capital in his assessment that market performance in the shorter term; will continue to be driven by political developments and central bank action.
My Lessons going forward: Endeavour to keep my trading to a minimum, ignore the litany of doomsday predictions and continue managing my temperament.