Each week, a professional investor tells MoneyWeek where he'd put his money now. This week:Francis Brooke, manager of the Trojan Income Fund.
We are more optimistic about stocks than at any time since our company, Troy, was established in 2000. Equities were overvalued in the 1990s, and that has now been reversed. Stocks have not looked this cheap since the 1980s, when high equity returns were driven by the fundamentals of earnings and dividend growth. If we are correct, this is the best buying opportunity for nearly 30 years.
Our optimism is not shared by others, so you will have to be highly selective. Unusually, the stocks and sectors which led the market decline will not be the ones which lead the recovery. We expect banks to lag returns will suffer from slower loan growth and tighter regulations and be diluted as the banks issue new stock to raise funds. We also believe that returns from mining shares will be depressed by lower commodity prices and the lagged impact of over-investment in the past five years. It is also too early to buy into small and medium-sized companies. They outperformed the FTSE 100 for eight years until 2007, and are overly exposed to the weakening UK domestic economy. Instead, we believe the rally will be led by some of the largest companies in the market. A concentrated portfolio of blue-chip stocks with a high level of overseas earnings will be the most effective way to take part in a rally which may be much stronger than investors expect.
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Oil major BP (LSE:BP) is one stock we expect to be a market leader. At 520.75p, the shares yield 6.3% and are on a prospective p/e of below six times. The dividend has grown by more than 13% a year for the past five years and is highly likely to grow in real terms in the future. Concerns about the weakening oil price are overdone and BP is a good example of a high-quality stock offering superior returns to those now offered by cash and gilts. Even at $50 a barrel, BP generates vast amounts of cash and has a strong balance sheet with high levels of interest cover.
We continue to favour international consumer stocks such as Cadbury (LSE:CBRY). The confectioner generates impressive volume growth of about 6% and we believe that the management team can improve margins further. This should see earnings growth beat City expectations. In tough times we expect demand for confectionery to stay resilient, so Cadbury's unique portfolio of brands will thrive.
Another attractive stock is AstraZeneca (LSE:AZN) which at 2,373p yields 4.5% and stands on a p/e of 8.7 times. Although the major drug firms do suffer when drug patents are challenged from time to time, we believe that the underlying strength of the firm's franchises and their cost-cutting abilities make AstraZeneca worth investing in.
All three of these companies are global businesses whose profits come mainly from overseas. These are the sorts of equities we expect to perform best over the next year or two. One final thought the current preoccupation with the threat of deflation has caused a slump in index-linked gilt prices. But if the measures being taken by governments and central banks around the world are successful, this will have inflationary consequences. The current real yield of 4.1% on the 2.5% Treasury 2013 issue looks an extremely attractive hedge against future inflation for longer-term investors.
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