A professional investor tells MoneyWeek where he'd put his money now. This week: Dr Savvas P. Savouri, managing director of QuantMetrics
Investors who build portfolios stock by stock might think that taking a macro view is unimportant. However, constructing portfolios bottom-up can leave investors with an unintended macro bias. That's why some fund managers employ diagnostic tools that screen stock portfolios for currency, interest rate or other discernable macro tilts'. But rather than being an unintentional byproduct of individual stock selection, a macro tilt could instead form the cornerstone of an entire portfolio. As the basis of what follows, we adopt a non-consensual view on the dollar.
The French and Dutch rejections of the European treaty has forced the euro to a nine-month low against the dollar. A number of forex specialists argue that the dollar's rise will continue as the EU descends into constitutional chaos. This should favour dollar earners and exporters such as Aga Foodservice, BP, Enodis, GKN, Hanson, ICI, IMI, Pilkington and Rolls-Royce. Such a bias towards industrials is reinforced by the perilous state of the UK consumer. However, we would argue that a tilt away from consumer cyclicals and towards industrials will not prove profitable on a 12-month view.
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To understand why we are stubbornly favouring the euro over the dollar we need to abstract from political-economic events developing in Europe, and focus on what is unfolding across the Pacific. The US is pressing China to revalue the yuan. For UK stocks, the implications of a yuan correction would be considerable, causing dollar-biased portfolios to seriously underperform in its wake.
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If the dollar were to be "devalued" against China's yuan, it is almost certain that it would slump against the euro and the pound. So instead of weighting your portfolio towards trade-cyclical stocks whose earnings come from overseas, you should favour high-yielding utilities (United Utilities, Scottish Power), rate-sensitive consumer cyclicals (Whitbread, BSkyB, GUS, Next, Dixons and Kesa), homebuilders (Persimmon, Redrow) and mortgage banks (Bradford & Bingley, HBOS, Northern Rock). We would also recommend the mobile operators Vodafone and O2, with their growth qualities in a weak economic environment.
Why do we take a relatively positive view on the UK economy when British consumers currently show little appetite for spending? If the pound approached two dollars, this would act as a deflationary force on the UK economy, which would encourage the Bank of England to ease rates. The positive implications for rate-sensitive retailers, including GUS, Next and Dixons, means they should outperform.
However, companies such as Signet Group have sizeable US earnings, which leave them exposed to a falling dollar and a weakening US consumer. Finally, readers will notice we avoid Boots and Marks & Spencer which, bids aside, we feel are vulnerable to margin-sapping and competitive price deflation.
We cannot close without pointing out that a sharp fall in the dollar would almost certainly coincide with a marked rise in US lending rates (contrast this with our view that UK and euro rates should move lower). The adverse implications of US economic stagflation for stocks such as Enodis, FKI, Hanson, ICI, IMI, Invensys and Wolseley, and for other large dollar earners would be significant.
