And when they were up, they were up,
And when they were down, they were down,
And when they were only half-way up,
They were neither up nor down."
I am sure this popular nursery rhyme brings back some childhood memories. Can you still remember those actions? Standing up, sitting down and then hovering halfway!
Time to review
The market has been on a march for the last six months, another leg of a liquidity-fuelled rally supported by global central banks. Last week Ben Bernanke’s testimony hinted at the beginnings of a QE withdrawal as the US economy sustains a recovery led by the housing market and the consumer. However, the market reaction must have terrified Bernanke and his fellow Fed members.
Clearly the Fed is still walking in the shadows of the two previous occasions when QE was withdrawn in 2010 and 2011. Both led to sharp market corrections. I am not sure whether this latest reaction is enough to shake the bull markets out of their complacency, but I do believe it is time to review the investment style of our equity portfolio.
Indeed, in a recent market commentary, Invesco Perpetual’s Neil Woodford commented "the overall market is no longer as cheap as it was, but some high quality, dependable, growth companies remain significantly undervalued."
Leading the way
Typically, in Grand Old Duke of York style, the same market leaders, whether it is an index, sector or a stock tend to lead on the way up and then back on the way down.
Recently, for example, Japan, which has been one of the strongest market performers over the last six months, suffered one of the biggest falls. From our fund analysis at North Investment Partners, we have found reliable, high yielding, large cap, defensive stocks have performed well over the past three years and fared particularly well over the past quarter.
Sectors such as pharmaceuticals, utilities, tobacco and consumer staples have flourished in a low yielding environment. These are the bread and butter sectors for UK equity income managers to construct their income portfolios.
Stretched valuations
While companies in these sectors remain in very good shape, valuations are getting stretched. To make meaningful strides from here we would need to see a more sustained economic recovery.
With signs the market may be preparing to descend from its recent peak, we are wary of the ‘Grand Old Duke of York’ effect. There are opportunities which are yet to reach their peak and some of these sit within the UK equity income fund universe.
Many quality businesses have raised net cash and at some point need to decide whether to reinvest or return to shareholders.
Furthermore there are companies that have strengthened their balance sheets post the credit crisis and remain undervalued.
Consequently, we are reviewing our funds with a preference for the stock pickers with a robust and disciplined approach to finding undervalued assets.
