Shares digital

Nimble defensive play is the order of the day as market’s tumble over the financial rocks. Russ Mould shoots the rapids

February’s month-long rally took the FTSE 100 back above the psychologically important 6,000 level and prompted many to wonder whether spring could see the first green shoots of recovery in equity markets. However, the sudden implosion of London-based hedge fund Peloton Partners, the collapse of Amsterdam-listed mortgage bond fund Carlyle Capital Corporation and the fire sale of American investment bank Bear Stearns (BSC:NYSE) dashed such hopes. Despite a rally earlier this week, indices in markets as flung as Shanghai, London, Tokyo and Mumbai remain mired near their year’s lows.

But it has not all been doom and gloom. Investment strategies featuring currencies and commodities, for example, have reaped rich rewards for those with enough capital and the courage of their convictions to get involved.

As predicted by Shares (4 January) crops have lead the way and the biggest gainers have been cocoa and palm oil, which have generated percentage gains in the low to mid teens. Wheat reached all-time highs earlier this month, after Kazakhstan announced export cuts and global inventories fell to 30-year low, while rice has reached a 34-year peak.

Supply problems have also boosted precious metals. Platinum and palladium have offered excellent returns, helped mainly by the ongoing electricity crisis in South Africa. However, precious and base metals alike suffered a sharp pullback last week, raising the issue of whether the recent price spikes have been because of fundamental economic demand or speculation amongst the investment community. It does seem logical that an economic slowdown would hit demand for industrial metals and also oil, which pulled back sharply from $110 to barely $100 a barrel last week.

Oil and mining stocks have failed to feature prominently in the recent sector performance statistics (see table) despite recent commodity price strength. It will therefore surely be hard for these stocks to perform if commodity prices falter in earnest and investors should be wary of these previously market-leading and still over-loved stocks.

Currency investors have found the going easier, as last year’s successful strategy – avoid the dollar – is again paying off in spades. The greenback fell below Y100 earlier this month for the first time since 1995 and recently reached an all-time low of $1.577 against the euro. The only currency against which the dollar has held its ground is the equally enfeebled pound sterling, as the UK’s high levels of debt and tightening fiscal policy leave the economy at serious risk of a hard landing.

Finally, 2008 has been an undeniably tough year for equities. The FTSE 100 has fallen by 15% and America’s Dow Jones Industrials 7%. Japan’s Nikkei 225 has dropped 20%, hampered by the rising yen and uncertainty who will replace Toshiko Fukui at the Bank of Japan. Even emerging market favourites China and India have failed to decouple from the West’s woes. Both have fallen by over 25% in 2008.

An injection of $436 billion into US overnight inter-bank lending markets and the offer of loans to Bear Stearns, the first loans to a financial institution other than deposit-taking banks since the 1930s, shows the US Federal Reserve has moved from crisis prevention to crisis management. Equity investors should take the hint and hunker down in defensive, cash-rich stocks. Despite last week’s pullback, gold should remain a helpful safe haven.

Shares says:

Buy Gold

Buy Defensives

But don’t chase equity market rallies.