To put these returns into context, the annual average real rate of return since the 1950s in the UK is 6.6% for equities, 1.8% for corporate bonds and 2.2% for gilts. It was a great year for the UK, a truly memorable summer of sporting achievement and a sparkling Diamond Jubilee to set the scene. Unemployment is down, retail sales are up and even the housing market is showing signs of life.
What’s not to like?
On the international stage the US has navigated through a difficult period and re-elected president Obama, Europe is making headway and working towards solutions for some of the more fundamental issues that lie at the heart of their problems. In fact, the pivotal point in 2012 for the markets was in July when there was the “whatever it takes” speech from Mario Draghi. Even Japan, the economy we all strive not to be like, saw its stock market return nearly 20%.
So why do so many commentators tell us that our life is miserable? Are we destined to feel as though our glass is permanently half empty?
Well for a start we are constantly being told that global growth is muted, the UK economy is in a mess and that fiscal austerity will be with us for the foreseeable future. I agree with all that but, as I have mentioned before, we don’t invest in economies, we invest in companies.
Clearly we need to remind ourselves that earnings and valuations are the biggest determinants of returns for investors, not economic growth. Uncertainty and lack of confidence leads to cuts in investments spending and that is why it is so important to get a balanced view.
Throughout 2012 I felt that many companies offered exceptional long-term opportunities and although I had my resolved tested in the first half of the year, the strong underlying fundamentals of some of these companies came to the fore in the second half. So in terms of my score card for 2012 it was definitely a case of a shaky first half when I failed to realise the extent to which macro drivers would dominate, but came good in the second half as the valuation and earnings potential shone through.
What about 2013?
JK Galbraith commented: “There are two types of forecasters: those who don’t know, and those who know they don’t know” and his words are reflected in two recent discussion papers.
They highlighted the problem with economic forecasting; one from the Bank of England’s External MPC Unit and another from the IMF. Fortunately, I can summaries both for you by exclusively revealing that forecasting economic variables has not been very successful in the past.
Shocked? I don’t think so.
As we know all too well in the UK, we have seen huge forecasting errors from successive governments followed by the inevitable revisions to timelines and targets that make us ever more sceptical and pessimistic about the economic outlook, hopefully this revelation doesn’t come as too much of a surprise.
If the past five years have taught us anything it must be that controlling the macro environment is at best problematic. Trying to predict economic outcomes when we simply don’t understand what affects the current strategies deployed by central banks and politicians will have, is pointless.
Despite last year’s strong moves, I think that many companies are still good value on a variety of different measures, including cyclically-adjusted ones, and relative to other asset, particularly government bonds, they remain my favoured investment.
Something positive
And despite my scepticism on economic forecasting, certain economic factors, particularly in the US, look to be improving and as a consequence could lead to greater levels of confidence and a better backdrop for investors. Institutional cash levels are also at a level that could, given a positive backdrop, push the market as a whole higher as we have seen in the first few trading session of the year so far.
I feel recent talk of a cyclical bull market is too optimistic at this stage, but remain convinced there is an opportunity to invest at levels consistent with strong positive real returns on a medium to long-term basis. In 2013, I think that quality will continue to do better than value and that cyclicals will do better than defensives. Having global diversification will also be key to mitigating risks.
Estimates for global economic growth and macro events will continue to exert undue influence on the market in the short term with the inevitable volatility. However, for the fundamental stock-picker there are plenty of opportunities; buying quality, well-run companies at attractive valuations will produce positive real returns, as long as you have the other necessary quality for a successful investment strategy – patience.
