Market commentary June 2006

It was widely reported that the cause of sharp falls was higher-than-expected inflation figures in the US.  The reality is that the US figures were not that bad, and this was reflected in the fact that bond yields fell, as did gold – both should have gone up if there were real inflation concerns.  As we set out in the last couple of months, the seeds for the volatility were sown some time ago – Japan signalled that interest rates will be going up, Chinese rates went up, and when Ben Bernanke said that US rates might not go up much more, he wasn’t believed.

Widespread falls were triggered by a mix of over-speculation (fuelled by low interest rates) and concerns that rising interest rates will lead to somewhat lower global economic growth.  By end 2006 we are as likely to be worrying about deflation as inflation.

Over the long term the difference between successful and unsuccessful investors tends to be patience.  Investors in UK equity income funds and India should reflect on this.

In the first quarter of 2006 our experience was that the greatest unprompted demand was for India funds.  This was at a time when this market had more or less doubled in the previous 12 months, and we were aware that fund managers with a broad Asia or emerging market brief had been sellers.  On the whole these UK-based enquirers took the advice to opt for more diversified funds.  But not so in India itself, where money was being borrowed at 19-21% to be invested in their domestic stockmarket.  One commentator felt that this suggested a “level of financial naivete that probably surpasses the gullibility at the height of the dot.com mania”.

In contrast, though UK equity income funds were up handsomely over the last year, a number underperformed the stockmarket as a whole. The attractions of the higher yielding shares into which these funds invest were spurned in favour of highly charged commodity and resource stocks.  Now those “boring” high yielding shares should come into their own.  Take the example of HSBC.  The company is well diversified geographically, is exposed to high growth markets, and conservatively financed.  Since 1991 the dividend has grown by an average of 16% per annum.  Yet these attractions have been relatively over-looked and the current yield is 4.5%. These sorts of gems populate the best UK equity income funds.  Buy and be patient.