International trade keeps top UK firms in the comfort zone

This year has surprised everyone with spectacular performances in both world equity and world bond markets.

After the disastrous performance of stock markets in 2008, and despite warnings from experts that we were heading for the worst economic downturn since the Great Depression, 2009 has surprised everyone with spectacular performances in both world equity and world bond markets. In the UK, for example, the FTSE100 index of share prices for the largest 100 companies has risen 54 per cent since its 2009 low value in March. The year to date increase is a respectable 22 per cent and, with just a few days before the year end, 2009 promises to be the best performing year for UK equities since 1989.

This remarkable performance appears, at first sight, to be at odds with the UK economy, which technically remains in recession since the year's third quarter recorded a small drop in Gross Domestic Product. But, fortunately, the top UK companies have international status and derive two-thirds of their earnings from overseas where national economies have rebounded faster than that of the UK. Thankfully for the rest of the world, Gordon Brown's influence on economic policy extends no further than the English Channel.

Interestingly, the higher risk sectors that were pummeled the most by the credit crunch and subprime crisis, have also bounced back the most. Funds which specialise in small UK companies, for example, were the worst performers in 2008 with an average decline of 48 per cent. But in 2009 they are, so far, the best performers with an average gain of 50 per cent according to figures from Morningstar. Global emerging market funds were also hit hard in 2008, falling by 38 per cent in sterling terms, but have bounced back miraculously with the best sector performance of 54 per cent growth so far this year.

Only two sectors failed to produce any growth in 2009 - Japan equity funds are down by an average of 2 per cent and UK gilt funds are down 1.5 per cent. According to most analysts, share prices in 2010 will have a much more difficult time as governments stop pumping newly-printed bank notes into the system. They are predicting that "defensive" sectors such as utilities, tobacco and pharmaceuticals that are usually able to maintain high dividends during tough market conditions, will prove to be attractive.

Funds which specialise in these kinds of company shares are referred to as equity income funds. During 2009, they underperformed in comparison to small company growth-orientated stocks. But in 2010, they should rise to the occasion. Most fund managers expect emerging markets to continue their impressive upward movement. Brazil and Russia, so far this year, according to MSCI indices, have risen by a phenomenal 96 per cent and 82 per cent respectively (in sterling terms). Impressive indeed, but it should be noted that it requires a 100 per cent annual growth rate to recover from a previous year's decline of 50 per cent.

As a result, most equity markets are still short of their recent peak values in October 2007. Many UK analysts thought that US markets would lead the world in 2009 in response to low interest rates and the injection of huge quantities of Government money. However, according to Morningstar, US equity markets have returned an average of 18 per cent to UK sterling investors, as the weakening dollar has eaten into profits. This is much less, for example, than the 48 per cent return from Asian equities.

The strong performance of Asian markets was significantly influenced by China's US$600 billion (Dh2.2 trillion) stimulus package, and some analysts believe the bubble will burst in 2010. This view is countered by an equal number of analysts who argue that the region's governments, corporations and individuals, unlike those in the West, all have healthy balance sheets with little indebtedness. Far East economies, according to this analysis, are poised for further growth. European funds, like those in the US, have lagged considerably with a year to date growth of 19 per cent compared to funds in the UK. The UK has greater exposure to banks and mining companies, both of which have risen from their low values at the start of the year.

The performance of bond funds has been mixed. Higher risk bonds produced the best results as the default rate among issuers proved to be a lot lower than originally anticipated. The credit crunch caused investors to be over pessimistic about bond valuations and provided a perfect opportunity for astute investors to buy bonds at remarkably low prices. High yield corporate bond funds have produced an average gain of 47 per cent so far this year. Strategic bonds funds, on the other hand, take less risk by mixing in higher quality bonds whose prices did not plummet during the credit crunch. Consequently, their growth this year was more subdued but, nonetheless, very acceptable at 22 per cent. Gilt funds, where the risk of default by the UK government is negligible, did not suffer during the credit crunch, and therefore did not generate a low price buying opportunity.

As a result, they are down 1.5 per cent over the year, so far. Interest rates are expected to start rising again in 2010 - they have nowhere else to go. When this happens bond prices will drop, so investors should avoid government gilt funds and low risk, investment grade, corporate bond funds. Instead, go for high -yield bond funds or, if you think there is too much risk in these, choose Strategic Bond funds that use a variety of all bond types.

Lastly, commercial property funds provided some of the worst performances in 2009 with an average gain of only 11 per cent. However, rental yields have risen appreciably over the last few years to the point where property valuations are now looking low. This suggests that now is a good time to buy commercial property. Bill Davey is a financial adviser at Mondial-Financial Partners Dubai. If you have any questions on this article or any other financial matter, he would be happy to hear from you at [e-mail]