Secrets of Success: It can pay to ignore polls and pundits

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The Independent Online

Barring last-minute accidents, it looks very much as if 2004 is going to turn out to be the kind of respectably positive year for the stock market that not many people seemed to expect a year ago; and that it will vindicate those of us who thought a reasonably bullish, contrarian view made sense. Not for the first time, it has paid to stick to the long-run factors at work - not least the typical behaviour of markets in US presidential election years - and ignore the opinion polls and all the other noise that gets in the way of a rational set of market expectations.

Barring last-minute accidents, it looks very much as if 2004 is going to turn out to be the kind of respectably positive year for the stock market that not many people seemed to expect a year ago; and that it will vindicate those of us who thought a reasonably bullish, contrarian view made sense. Not for the first time, it has paid to stick to the long-run factors at work - not least the typical behaviour of markets in US presidential election years - and ignore the opinion polls and all the other noise that gets in the way of a rational set of market expectations.

It was interesting that the easy John Kerry win that the late exit polls and many media commentators were assuming until quite late in the day in the US election was usefully contradicted by the weight of money on the betting exchanges, which in one case had George Bush as strong odds-on favourite, despite the headlines elsewhere. It often pays to look at what the smart money, rather than smart punditry, is going for in events of this kind.

There seems no reason, in the short term, not to expect the current rally in the markets to continue until the end of the year. It is too early to start looking at next year and beyond, but for the moment there is some reasonable momentum building in the main market indices. This is despite the continued problems that a number of large and well-known companies, from Marks & Spencer to Prudential, are currently experiencing. The medium-term strategic call to look at commodities that was being made 12-18 months ago by the likes of Jim Rogers and Marc Faber, reported in this space, meanwhile continues to look soundly based.

Looking at the past five years' figures for the main indices also throws up interesting confirmation of style trends that were highlighted here and elsewhere at the time of the bull market reaching its peak in 1999/2000.

As the TMT bubble reached its zenith, two comments in particular, from those whose opinions I like to track, remain in my mind. One was a comment by Anthony Bolton, Fidelity's star fund manager, in 1998 to the effect that he had never known small and medium capitalisation shares, the kind he specialises in, to be so lowly valued relative to their larger capitalisation cousins.

The second comment came from another seasoned fund manager with many years of experience behind him, Bill Mott of Credit Suisse Asset Management. He made a confident prediction in the spring of 2000 that shares with income and high yields would increasingly become the flavour of the day, once the bull market topped out. There were others who made a similar observation (there always are many prophets in hindsight), but this one seemed particularly worth recording, given the authority of its originator, and the lack of get-hedging in his remarks.

The latest five-year performance tables, taken from Standard & Poor's Fund Expert, confirm that both Bolton and Mott, in their different ways, were correct. Taking the main indices first, the five-year return figures to the end of October 2004 show the following results. The FTSE 250 index has returned 29.6 per cent and the FTSE Small Cap index 12.3 per cent; nothing to get excited about, to be sure, but not unreasonable, given that we have been through the worst bear market in a generation.

By contrast, the FTSE All-Share index has produced a total return loss of 8.6 per cent and the FTSE 100 a negative return of 14.5 per cent. Successfully rebalancing your portfolio away from large capitalisation shares to small and medium capitalisation issues, as Bolton suggested, would therefore have been a useful thing to do.

In the same way, over the same five-year period, the FTSE 350 High Yield index has returned 25.2 per cent, while the FTSE 350 Low Yield index has produced a negative return of 39.4 per cent. It is true that comparing these two indices, which simply rank the component companies in the FTSE 350 index by their dividend yields, is a rough and ready way to measure the performance of dividend-paying stocks. But the huge disparity between the two figures does capture a clear and unmistakeable trend - the one that Mott was forecasting.

One reason why these two trends were not that difficult to forecast at the time (though many missed them) was that the experience of the previous few years had been so different. Large cap shares as a group were soaring in value at the time of Bolton's comments - and, having the choice, investors were giving a much higher rating to shares with (apparently) superior growth prospects than they were to dividend-paying shares. In the long run, all these so-called style effects largely cancel each other out, so you will not go far wrong as a medium-term investor betting that so-called "mean reversion" - the reversal of current trends - will occur in due course.

The same is also probably but less certainly true for the overall valuation of the markets: long bull markets will be followed by shorter bear markets, and vice versa; but at any given point, the timing and scale of trend reversal is virtually impossible to predict. You can grow old and poor waiting for a new bull or bear market, as many investors found in the latter half of the 1990s when growth and large cap continued to be all the rage, long after wise, old heads had warned that the bull market they had spawned was unsustainable.

Style trends, however, are more reliable, judging by recent experience. You need to have them on your side if you are to succeed in making money in difficult market conditions: one in four of UK equity income funds has made a positive return over the past five years, while only one in five of growth and general UK equity funds has achieved the same.

There is, as yet, no compelling reason to think the trends have run their course, though they must eventually reverse once more.

jd@intelligent-investor.co.uk

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