Central Bank’s dilemma of curbing inflation against rapidly falling growth will soon subside. Deflation will be the only concern, for inflation worries are overdone. Most people are not seeing increases in core inflation from any of the traditional indicators. Wages have not risen in real-terms and household wealth is declining. Purchasing power has fallen and as a consequence debt burdens have increased. But inflation in food and energy is acting as a consumption tax leading to a collapse in consumer demand.
Inflation is surging in emerging markets but it is creating a deflationary force in our developed economies. Interest rates will soon fall as rising unemployment and slowing growth become the major issues.
Ever lower P/Es and historically low valuations are currently no support for equities because forecast earnings are still too optimistic. Much of the bad news is already discounted, but it is the duration of the current financial and economic crisis that is the risk. The longer it goes on the greater the risks of rising unemployment and a prolonged decline in the economy. A lower cost of money will be an important kick-start to a recovery.
Our portfolio out-performed in June. Our concentration in energy and basic materials were the major contributing factors, particularly Tullow, BG, Xstrata and Amec. Following our theme that energy services and suppliers will continue to out-perform, Wood Group and Hunting were added to the portfolio.
Support Services
As companies increasingly concentrate on their core competencies, demand for support services has risen. In particular, those supporting the oil industry have benefited from the upturn in the cost of crude oil and historical underinvestment in infrastructure. These companies are better equipped to carry out non-core activities for clients and have seen sales and margins rise sharply.