Is defence the best form of attack?

The UK’s third quarter GDP figures proved disappointing. Output fell by 0.4% on the previous quarter, confirming the UK remains mired in the longest recession on record. However, the GDP data itself has been questioned, as most economists had been expecting a small rise in output. It is generally accepted that GDP data can be unreliable around economic turning points and separate business activity surveys suggest a resumption of growth. So, we suspect that the economy contracted by less than reported in the third quarter; expansion in the fourth quarter of this year remains a reasonable possibility.

Consumer price inflation has fallen from its recent peak of 5.2% in September 2008 to just 1.1% this September. A number of factors now conspire to start nudging it up again. Tax changes – notably, the return of VAT to its pre-crunch level in January 2010 – will be one of these. But sub-trend growth could result in increasing spare capacity in the economy, offsetting some of these upward pressures, so a persistently sharp rise in prices looks unlikely.

So, what does this mean for investors?

Considering recovery stocks is one approach. Particularly strong in this sector are Astra Zeneca (AZN) and Glaxo Smithkline (GSK). What makes these appealing is their strong fundamentals; - both have relatively secure dividends of +5% and PES of 10 or less making them potentially good value growth stocks.

Last week, positive news from the high street showing the strongest October retail sales growth in 7 years (3.8pct) suggests that there may be some mileage in cyclical retail stocks. Sainsbury (SBRY) announced, a 37% rise in pre tax profits over the same period last year and increased its final dividend from 3.6p to 4p.

Tesco (TSCO) has seen its first growth in market share for almost two years according to research firm TNS Worldpanel. The UK's number one supermarket has reaped the benefit of its double Clubcard points promotion and took 30.7 per cent of the grocery market, in the 12 weeks to 1 November. Looking closer, the fundamentals are strong, with an already relatively low PE at 11.4 and its highest final dividend in 5 years (8.39p) in Feb 2009, recent good news from the sector could be viewed as positive lead indicator for Tesco.

As an investment strategy, retail stocks, that are cyclical, combine well with pharmacuetical stocks which are defensive. In theory, should the retail sector resurgence fail to flourish, pharmaceutical stocks should not be affected.

The value of stocks and shares, and the income from them, can fall as well as rise and you may not get back the full amount you originally invested. House view on AZN (buy)/GSK (hold)/TSCO (accumulate).

Choose your next move

When looking at investor behaviour and opinion, it is often possible to see a clear pattern in terms of a consensus view on expectations of future market direction – at the moment however, the picture is less clear. Of course it takes opposing views to create a market, but opinion as to the shape of the recovery and the future direction of equity markets is extremely mixed right now.

Investors appear to feel nervous at the risks of being both in and out of the market – it seems that a sharp market move may be imminent, but in which direction?

With manufacturing output rising, PMI (Purchasing Managers Index) data pointing to economic growth in the UK, encouraging US GDP figures, US house sales higher for the eighth consecutive month and stability apparent across equity markets generally, the picture might appear rosy. But equally there are several pieces of evidence that are clearly causing some nervousness amongst investors – uncertainty over the future direction of the Quantitative Easing programme being implemented by the Bank of England, GDP figures confirming that the UK remains in recession being key elements that are unsettling investors.

In this Investment ViewPoint, we look at how you might look to protect your portfolio against a possible broad pull-back in equity markets or indeed how you might look to profit from such moves should they occur.

Firstly, let us look at defensive options – how to remain invested yet appropriately positioned in order to minimise any losses that may be incurred should there be a pullback or dip in the markets. The traditional ways to achieve this remain valid considerations today – look at defensive equity sectors such as pharmaceuticals or food retailers, areas that remain relatively stable in times of heightened volatility or weakness. Or you may wish to consider switching some of your portfolio into Fixed Income investments  View our Investment ViewPoint: Analysis – Are returns still Income-ing?

Alternatively, in order to retain exposure to equity markets, you may wish to look at our Structured Products. Currently there are no issues available in the primary market but in the secondary market there are a variety of products that you may wish to consider, such as the FTSE 100 Protected Defined Returns structured product

Finally, experienced investors may wish to consider the use of leveraged products in order to either hedge core holdings or even achieve outright short exposure with a view to profiting from a downturn in the market. Products that can be used to implement these strategies include covered warrants as well as CFDs and Financial Spread Trading

We will go into each of these areas in future publications, so please keep an eye on our secure research centre regularly and watch out for future Investment ViewPoints and Cotter’s Corner pieces.

As with all investments these asset classes carry different levels of risks and you can lose money as well as making profits.