Choose quality as markets climb

published 1 November 2006

Global stockmarkets are performing strongly. The US Dow Jones index has recently hit a new all-time high, although the wider equity indices are still shy of this achievement. In the UK, this has helped the FTSE 100 to move above the 6,000 level, reaching heights not seen for more than five years.

The FTSE 250 has achieved even greater returns over the last year, fuelled by a wave of takeover activity. Its relative outperformance has been helped by the poor showing from FTSE 100 heavyweights such as BP and Royal Dutch Shell, despite the strong oil price. Until recently, you could also add Vodafone, which has been battling to improve its image and deflect concerns that profits at its core mobile-phone unit are under threat. Another major prop to markets has been the large number of share buy-backs as firms raise balance-sheet gearing to reflect the cheapness of debt finance compared to equity finance.

Recent initial public offerings have struggled, though, and pricing hopes have been reined in. This suggests higher risk aversion among investors and that not everyone trusts current market moves. With the Bank of England widely expected to raise interest rates by a quarter point to 5% in November, energy costs still historically high, and a weak US dollar hampering exporters and dollar earners, it's easy to see why.

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We generally prefers larger stocks with good long-term prospects, as opposed to riskier areas such as online gambling. One of our current investment themes is the urbanisation of China. This looks set to continue for 20 years or more and will have profound effects on global economics, not least the extra demand for commodities and raw materials. The beneficial economic impact on the Asian region makes Standard Chartered (STAN) a very good choice in the banking sector. The management team is well regarded by the market. The same global-growth theme can be played through a broad-based resource stock such as BHP Billiton (BLT). Although subject to short-term commodity price fluctuations, the firm is well placed for the longer term.

Elsewhere, the UK life assurance industry has been through a traumatic period and many operators have stopped writing new business. Resolution Group (RSL) specialises in running closed life businesses and achieving extra efficiencies. It could grow profits and dividends further from current levels. We have also been long-term investors in Tesco (TSCO), the leading UK food retailer. The company has growth opportunities in its newer European operations, and in the USA, where it is launching a new start-up venture.

A final stock to highlight is BP (BP). BP has endured much criticism this summer, but is a major operator in the oil industry, producing large amounts of cash, much of which is being returned to shareholders. The share price implies a long-term oil price of around $40 per barrel. Given global demand, this seems

unduly harsh.

As markets climb higher the chance of a decline always grows and when that happens, it's the high-quality stocks, such as those mentioned above, that often fare better.