Reports of the death of equities are greatly exaggerated, says Rupert Elwes

This quote seems appropriate, based on the dilemmas and contradictions of 2011. The optimist spent last year focusing on the attractions of the equity markets, in particular the valuations, strong balance sheets and well-supported dividend yields of many companies. Meanwhile, the pessimists spent their time focusing on the universally poor macro news, especially with regards to the worrying developments within the European Union.

Winners and losers

Overall, 2011 was characterised by risk aversion, as evidenced in the outperformance of the US and UK Treasury markets, gold, and the perceived safe haven currencies of the Swiss franc, yen and US dollar. Within equities, this was reflected in the marked outperformance of the US and UK stock markets, with the former managing to register a modest gain for the year, in distinct contrast to the double-digit declines of the Asian, emerging and continental European markets.

The discrepancy between the winners and losers was similarly notable by sector, with the more defensively positioned and traditionally higher yielding utility, telecom, healthcare and consumer goods stocks registering strong gains (in many cases double-digit), versus the sharp declines of the financial and basic material sectors. Although this trend reversed somewhat in the fourth quarter, with a sharp rebound in some of the more economically sensitive sectors of the market, this once again gave way to greater risk aversion by the end of the year as Eurozone fears returned to the fore.

Nonetheless, while negative macroeconomic news dominated sentiment during the year, it was interesting that the decline in the FTSE World Index during 2011, at just under six per cent, was not worse. This is all the more extraordinary when you consider some of the tumultuous events witnessed over the last 12 months, for example, the Japanese tsunami, US debt downgrade, floods, earthquakes, revolutions, oil price spikes, and the European crisis. That equity markets did not register more significant declines, despite all of these events, highlights a remarkable resilience.

Losses seem to have been contained by a combination of factors. These include evidence of some concerted action from European politicians, as well as growing optimism that the US would avoid a double-dip recession and that China would engineer a soft landing, as well as some of the fundamental attractions of equities relative to other asset classes, as mentioned earlier.

Forward thinking 

Here at J O Hambro we tend to fall into the optimists camp. We appreciate that our guarded enthusiasm for equities could wrong foot us should certain events materialise. As such, we remain highly selective, with a continued emphasis on those high-quality companies that can continue to prosper in a low-growth world. We are looking to identify and invest into companies with strong balance sheets, pricing power, high barriers to entry and high returns on capital employed. Above all, we are looking for companies which are able to generate sufficient cash to sustain both reinvestment back into their business as well as paying out higher returns of cash to shareholders over the long term.

Looking further into the future, events unfolding in Europe, the Middle East and elsewhere around the world support the theory that we are in the midst of a multi decade re-alignment of political and economic boundaries '“ all part of the shift of power from west to east. However, the human mind struggles to analyse and comprehend events that play out over decades rather than days, and we should not underestimate the ramifications that such changes will bring, nor the investment implications and opportunities that are presented.  

Rupert Elwes is a director and portfolio manager at J O Hambro Investment Management Ltd