Mark Dampier: Unloved, out of fashion and just the medicine

The Analyst

Stock markets have led something of a charmed life over the last couple of years, rising strongly and recovering much of the losses incurred during the credit crisis. Shares became very cheap and the rise has been a logical one based on companies improving their profits sharply. Unlike governments and consumers, companies deleveraged quickly, paying down debt and putting themselves on a stronger footing. Stock markets are led up by profits, and these have been good even though the spectre of debt accrued by governments remains.

Stock markets are not immune to economic news. European sovereign debt issues came to the fore last year to spook the markets, and as I write there are jitters over a downgrade of the outlook for US debt. Yet on the whole the markets have marched upwards, perhaps luring politicians and investors into a false sense of security the worst is over and we can go back to normal. I'm afraid nothing could be further from the truth. Most of the developed world is still to address the problem of debt, perhaps because the figures are so huge nobody can comprehend what they really mean.

Bill Gross of Pimco, one of the largest bond managers in the world, believes off -balance sheet debt in the United States is running at some $75 trillion. In the UK it has been approximated at £1.73 trillion or 91 per cent of GDP. Off-balance sheet debt includes such things as public sector pensions and PFI initiatives. In the States it includes Medicare and other social security benefits, whose costs are set to spiral as the baby boomers retire and start to claim them.

To me the idea we can grow our way out of the current situation is fraught with difficulty. Consumers are being squeezed between price rises on one side and little or no wage growth on the other. So in the Western world we probably face an anaemic recovery for some time, which also means interest rates staying low. There may be a degree of tightening, as we have already seen from the ECB, and later in the year we may well see some from the Bank of England, but at present I can't see rates going back to the norm of the recent past of around 5 per cent given the indebtedness of governments and consumers. If they do we risk going straight back into a recession – a disaster for fragile Western finances.

So what are the implications for investors? With so much debt it is tempting for authorities to allow inflation to reduce some of the burden, so hard assets such as commodities have appeal. While I am a long-term believer in the industrialisation story in emerging markets, commodities such as base metals have already had a strong run, so I wouldn't be surprised to see some weakness in the near term. However, I exclude oil and gold from this. The former is likely to have a risk premium associated with it given that much of the world's supply comes from areas at risk of political instability. The latter because governments are devaluing their currencies through methods such as quantitative easing. No one really knows the true worth of a bar of gold, but what is for sure is that it can't be devalued by politicians, and when investors worry about currencies they turn to gold.

Another area to look at is large global companies whose shares have de-rated over the past decade years since their all-time highs at the turn of the century. They now look cheap, having increased earnings and shored up their balance sheets. They are generally unloved and out of fashion, especially the pharmaceutical sector where many company valuations are at 20-year lows. I am reminded of the words of Sir John Templeton, one of the most famous investors of all time, when he said: "To buy when others are despondently selling and sell when others are avidly buying requires the greatest fortitude and pays the greatest potential reward." This is perhaps a good time to employ these wise words. I remain a long-term fan of commodities but they have become a very crowded trade, whereas many investors seem to have given up on pharmaceuticals.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent