December 2007

December has arrived and I am presented with an opportune time to review the trading year. Active portfolio management during 2007, if one had been positioned well, would have yielded some very solid returns. The blue chip index itself however would have delivered largely a flat performance on capital but with approx 3% by way of dividend. This is the return an investor in a passive index tracker fund would have received across the year. An overweight position in the mining sector (as opposed to banks) would have significantly boosted returns.

There were wild point swings in the FTSE100 as we progressed through the calendar. Starting at 6220 in January, we watched it rise to 6730 in June before falling severely to 5850 by mid July. It then rallied strongly back up to the 6730 level again by mid October and as I write we are trading at the 6300 level having got close to the all important psychological and technical 6000 level in mid November.

After a solid first half, still amidst an environment of thriving M & A activity, the blue sky type market landscape changed. With the index healthy in June and with inflationary concerns on our minds, sub prime lending problems were emerging in the US. The mountains of debt which had built up through a period of very low interest rates were starting to re-surface with problems attached. Irresponsible lending to individuals who should never have been afforded a loan came back to haunt investors who knowingly (or unknowingly) possessed such now ‘securitised debt’ as stock in their portfolios. Suddenly the prices of these stocks plummeted resulting in an ultimate freeze in credit markets globally: a banking crisis, the like not seen for decades was upon us whilst many were probably on the beach with their families on holiday.

These conditions between June and August precipitated a 13 % correction in the market as banks essentially refused to lend to each other, lacking the trust imperative to the day to day functioning of the capital markets. Financial socks were sold down aggressively as concerns relating to potential exposure to sub prime gripped investors with fear. The lack of available credit also impacted enormously the M & A market with takeover deals being well and truly back burnered. Infact, it is still on the back burner and clouds remain with credit spreads remaining wide and interbank lending rates markedly higher than base rates.

The market then climbed a wall of worry back to the 6730 annual highs by mid October, focusing on positives going forward with beliefs centre on improved credit markets and recessionary conditions (both in the US and UK) being avoided. As I write however we have slipped back to 6300 as recessionary concerns prevail alongside almost desparate pleas for interest rate cuts. Emerging markets continue to grow strongly as does their demand for commodities and mining stocks have continued to be breathtaking investments with BHP Billiton (for example) up 68% over the year. Many remain upbeat on this sector still.

Is the 4.5 year bull market close to being over ? A number of indicators would suggest perhaps it is; corporate earnings are flagged up to slow next year, the oil price remains high and what will be the impact on consumer confidence of the now weakening property market ? The flip side : shares in general are arguably not expensive, already priced for a slowdown.

Many investment banks and divided on their predictions for 2008. The concerning macro economic headwinds do make it easy to see the bear market case. But if interest rate reductions have the desired stimulatory effects, many stocks may rally going forward: Media and retail stocks for instance.

In terms of advice in the current climate: keep a sound spread of stocks in the portfolio perhaps with a defensive bias and a cash weighting. As an asset class in its own right, cash should not be underestimated : it never goes down in value (inflation accepted).