Cotter's Corner 2012

Published on 11 January 2011

Looking back looks grim
In case you had not noticed 2011 was not a great year for the investor! The only significant stock market index that rose in the year was the Dow Jones 30 in the USA which ended the year up about 5.5%. Notably this was its third consecutive year of growth. The S&P 500 was flat but elsewhere around the world it was just a question of how much the indices fell. In the UK the FTSE 100 was down 5.65% but further afield the performance of the stock market indices was much worse.

Brazil (Bovespa): -18%
Japan (Nikkei): -18%
India (Sensex): -19%
Russia (Micex): -21%
Hong Kong (Hang Seng): -21%
China (Shanghai Composite): -22%

Closer to home in Europe as you would expect the figures were equally grim;

Greece (Athex): -52%
Italy (MIB): -25%
France (CAC 40): -17%
Germany (DAX 30): -14%
Spain (IBEX 35): -13%

So whether you were an investor in the BRIC’S or one of the “PIIGS” it was a very bad year. Well, all except for one very little piggy in the shape of Ireland where the ISEQ actually finished up 0.6%! In relative terms a truly amazing fact as after Greece it was, and probably still is, one of the epicentres of the European sovereign debt crisis.

When you view the UK performance against this background it makes things look a little better for the FTSE 100 focussed investor. No doubt some newspapers in the UK seeking to dramatise will still talk about £90Bn being wiped off the value of shares in the year.  However, in the cold light of day the facts show the FTSE 100 dropped roughly 5.65%. When you add back the average dividend for the investor who looks at overall return, the actual loss becomes more like 2%. To be honest it felt a lot worse than this.

A game of two halves
As you will see from the FTSE 100 graph below the year in the stock market in the UK was basically a “game of 2 halves”. The first six months saw the index moving sideways around the 6,000 level. This trading range was interrupted by the tragic earthquake and tsunami in Japan in March but as you will see from the graph its impact on world stock markets was relatively short lived. By the time April came around our premier index was back above the 6,000 level.

 Past performance is not a reliable indicator of future performance. Short-term past performance of less than one year is a particularly unreliable indicator.

The second half of the year was dominated by political gridlocks - first in the USA and then in Europe. In the USA after much public disagreement Barrack Obama eventually signed legislation designed to reduce the fiscal deficit by $2.1Tn. This was regarded by the risk agency Standard and Poor’s as about half of what they would have considered (to use their words) as “a good down payment”. In the light of this they promptly withdrew the AAA credit rating for the USA for the first time in history and in response the FTSE 100 fell by 1,000 points.

The rest of the year witnessed a tug of war between the micro tailwinds (cheap valuations and strong earnings growth) and the macro headwinds (sovereign debt and unemployment levels) which resulted in an extended period of directionless volatility. Although the market was in a relatively tight trading range one third of the trading days saw up or down movements of 100 points or more.  Admittedly an opportunity for the leveraged swing trader but frustrating for long term investors like myself.

Cotters XI for 2011 – in review
Cotter’s X1 for 2011 did not cover themselves in glory! In fact without the solid performance of the back four it would have been a battle against relegation.

As you will see from the January 2011 Corner the three themes I wanted to follow in the year were;

1. Large Companies with Global exposure that paid significant dividends
2. Exposure to commodities via miners and upstream oil companies
3. Exposure to USA and emerging markets

The only call that was absolutely right was the first as the group selected ended 6% up on the year. Individually Glaxosmithkline(GSK)was the best performer with a 15% gain. When you add the dividends to this performance you can understand why large dividend paying companies with Global reach was the right call for the year. A view that is confirmed by the fact that the Dow came out on top of the annual index table (the Dow being made up of the top 30 Companies in the USA by market size all of which are relatively high dividend payers).

If the back four did well I am afraid the same cannot be said for my midfield and the strikers. The call on the miners and emerging markets was totally wrong. The impact of this mistake was made worse by the fact that both these areas are high beta and therefore will tend to move more than the market generally i.e. outperform a rising market and underperform a falling one. This theory was certainly proved on the downside last year.

Looking ahead looks better
I suppose the two main questions that are on investors minds as we enter the New Year are;

1. If, when and how does Germany pay for the rest of the Eurozone?
2. Will China have a hard, soft or no landing?

I want to put the first question aside for the time being. The Euro never made sense to me from an economic standpoint. It was a political union not a financial one and therefore will require a political solution. One can only hope that the political leaders will lead more decisively in 2012 than they did in 2011.

For me China is the key to world stock market performance in 2012 not only because it is the World’s second largest economy but also its performance I believe will go a long way to dictate market sentiment. In the markets, as in life, expectations have a habit of being fulfilled. The US is doing its best to change people’s negative perceptions. It is about to announce its 11th consecutive quarter of growth. However, I think we need we need a turn around in Chinese markets to help dispel the fear that has left the rest of the World markets in a downward spiral.

China is notoriously difficult to interpret because despite the fact that it is a micro managed economy, available data is limited. Nevertheless despite this and the awful stock market performance of 2011 I would definitely want China on the asset side of my personal balance sheet in the New Year. Not for its potential as an exporter which is likely to be a neutral influence on its GDP figures (the downside of Europe balanced by the upside of the US) but for the potential growth in its domestic market.

Obviously in recent years there has never been a problem with the GDP growth figures. Viewed with western eyes they can only be looked upon with envy. However, the stock market and the economy are very different things and the miserable performance of the Shanghai Composite index quoted above seems totally irreconcilable with the 9%+ growth in the economy. The concern in 2011 that pushed stock markets lower was the rate of inflation and the possible future impact of the measures to control it taken by the Chinese government. It seems as we enter 2012 that inflation is beginning to be brought under control without killing the growth. If this turns out to be the case and a hard landing of the economy is avoided the potential for growth is obvious.

This is one of the issues covered by the January issue of Compass (See page 13). It confirms that Chinese wages have tripled over the last 10 years and they are expected to continue this trend. They have therefore more than kept pace with inflation so the buying power of the Chinese consumer has not been eroded. The figure that really catches my eye is the fact that at present only 36% of GDP is taken up in the domestic market. This as the article in Compass points out is the lowest home based consumption of all the large economies and clearly underlines its potential to grow.

Cotter’s 2012 formation
With all of this in mind I am not going to change the game plan for Cotters XI in 2012. I am still looking to focus on the same themes and hope that the midfield (seeking growth via commodity related plays) and the strikers (focussing on the US and emerging markets) can this time pull their weight.  I will still play a 4-3-4 system, with no goalie so maybe that is why I lost last year!

The only change I will make to the back four is to drop AstraZeneca and bring in Vodafone (VOD) - once again a large global business paying a high dividend.

In midfield I will keep Tullow Oil (TLW) which gave a solid Scott Parker like performance in 2011 with growth of 8%. Medusa Mining (MML) gave a Balotelli like performance last year - an absolute star in the first half and rubbish in the second. However, I still have faith in this gold miner and will retain it in my team. I will replace Xstrata with an Investment Trust, BlackRock World Mining (BRWM). This will still give me exposure to the mining sector but in a more diversified manner and at a significant discount to its asset value.

With regard to the strikers I will retain the DB X-Tracker (XRU2) tracking the Russell 2000 in the US. In 2011 the small caps significantly underperformed their big brothers so they may well rebound better this year. I will also retain despite its performance, Fidelity China (FCSS) under the management of Anthony Bolton and hope, as he deserves that he will go into retirement with a bang not a whimper. I will add another US focussed ETF in the form of the iShares S&P 500 (IUSA) and on the wing I will add a little bit of flair in the form of the iShares Brazil (IBZL).

The team for 2012 therefore reads; 

Sitting on the subs bench isn’t for me
One final point I want to make relates to the danger of being out of the market. I know many friends and customers who have dramatically reduced their equity exposure over recent months. Whilst I quite understand why people might move away from the higher risk of equity investments at times like this they should not only focus on the risk of being in the markets but also the risk of being out.

Striking figures emphasising this very point for the long term investor are included in this month’s Compass on page 28. Over the last 25 years global equity markets, using the MSCI World Index as a guide, have achieved an average yearly return of 9.4%. However over this time period if took away the best five days, the performance of world markets would fall from an annualised return of 9.4% to 5.3%. If you took away the top 15 days in 25 years the annualised performance would fall incredibly from 9.4% to 1.8%! In 25 years there have been over 6,500 trading days so a tiny fraction of those days have been responsible for the vast majority of the gain.

Past performance is not a reliable indicator of future performance.

With share valuations so cheap right now the danger of missing one or more of these key days is even greater in my mind. So think before you invest but think twice before you sell and sit yourself on the subs bench!

As ever, share prices can fall and you can lose as well as gain.

All the best for 2012 and good luck with your investments!

JJC

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Page last updated 11 January 2011

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