Market Commentary - April 2011

The inherent unpredictability of world events has once again challenged the nerve of investors across the globe. Both the political unrest in the Middle East and the recent earthquake in Japan carry with them a terrible human cost. They are also both unforeseen specific events and have the ability to have significant and long lasting consequences.

There is huge potential for the civil unrest in the Middle East to spread and the knock on effect this could have on energy prices could make the oil crises of the 1970's look mild. Likewise, the unstable nuclear reactors at Fuchushima Daiichi have raised the spectre of a radioactive contamination of areas of Japan, the like of which we haven't seen since the Chernobyl accident.

Having said this, such an outcome in either situation seems a remote outlier. At the time of writing the state of the nuclear reactors in Japan appears more stable with the likelihood of significant contamination receding. That the vast majority of us have at best only a rudimentary understanding of nuclear energy does not help, but the latest pronouncements from experts and Japanese officials do seem more reassuring.

Unrest in the Middle East and North Africa, however, carries with it a more well-established potential to upset the world economy. High oil prices directly impact on global economic growth at a time when it could do without the upset. The speed and effectiveness of the movements opposing the existing regimes has been surprising. That being said, the political, ethnic/tribal and religious context in each country is different. We are not witnessing a pan-Arab push for Western-style democracy - the picture is far more complicated.

While it may seem callous at times of such profound human tragedy, it is important to reflect on how these events impact us; and how our investments might be affected.

First, it is worth noting that so far stock markets have been relatively resilient. We have not seen a wholesale sell-off of risk assets (such as equities). There was much talk in the early part of the year about a market correction and what the catalyst would be. It appears now that we are witnessing it. Our view is that current volatility, while presenting a timing problem in terms of when to invest, actually offers a degree of opportunity.

The second outcome of current events might well be a ‘higher for longer' cost of commodities. While we don't yet know the extent of the rebuilding costs in Japan a significant infrastructure spend could well maintain the price of many commodities where they are; and oil prices are a complete unknown. There are some commentators who are predicting oil going to over $150 a barrel. This is going to mean that headline inflation figures are likely to stay above target in many countries, the UK included.

A belief that the inflationary outlook marginally favours equities and commodity linked assets above fixed interest holdings like gilts and corporate bonds, is our stock position right now - though the balance is fine. Our view of the corporate sector is that companies appear to have strong balance sheets, and while smaller companies may still have difficulty getting access to capital from banks; the current environment favours large global businesses with dominant market share.

Despite all the uncertainty of recent events the reaction of markets suggests that they can absorb even the most unexpected of geo-political shock. A far greater enemy is that current nemesis of the ‘Western world': debt. A repeat of last years Euro debt crisis in the shape of Portugal and potentially other countries needing to be bailed out would scare markets more - and reveal the dangerous fault line running underneath our economies.

28 March 2011