Shares digital

Now is the time to learn the lessons of the year, taking heed from who performed and who flopped. Russ Mould performs the post mortem

Stock market investors tend to be bombarded with pieces of advice and hoary sayings, some of which bear a resemblance to common sense and many of which don’t. One vital pointer which should be heeded is always look at trends in the broader market to see what they are telling you.

Despite the occasional breakdown and overshoot on the up, or down side, in indices or particular share prices, markets are generally pretty efficient. After all, global banking stocks began to underperform the broader equity markets last autumn, a good nine months before Bear Stearns (BSC:NYSE), Morgan Stanley (MS:NYSE) and others began to terrify debt and equity investors with the scale of their sub-prime market losses.

A peek at the FTSE 100 and which stocks have done well over the past one, three and 12 months may therefore reveal a few trends that are worth noting for 2008, providing some indicators for which stocks to buy and avoid.

The most obvious point is how mining stocks did well in 2007 as a whole but – with the exception of possible bid targets Rio Tinto (RIO) and Xstrata (XTA) – they dropped off the map in the fourth quarter. Base metals prices began to sag and the market has clearly started to factor in slower economic growth in 2008. After a great multi-year run, it may therefore be time to pick out the next market leaders.

The big winners in the final quarter of last year were generally defensive stocks, whose earnings and revenue streams are less exposed to the whims of the economic cycle than areas such as mining, construction or retail. Utilities, food retailers and tobacco stocks did well, while even big pharma came back into favour in the form of GlaxoSmithKline (GSK), despite concerns about patent woes and pipeline disappointments.

Investors should therefore take note and stick with such solid earnings streams as those offered by Reckitt Benckiser (RB.), Sainsbury (SBRY), Tesco (TSCO) and Unilever (ULVR).

It is also worth noting that bank, construction and real estate stocks – the real dogs of 2007 – disappeared from the list of the ten worst performers in the fourth quarter. A lot of bad news has clearly been baked in, with house builders trading on low valuations of their landbanks, real estate plays trading at 30%-plus discounts to Net Asset Value and banks offering huge yields.

A massive onrush of additional commercial property in 2008-09 and the prospect of a tough year for the UK economy in 2008, judging by December’s awful current account and budget deficit figures, suggests it is too early for construction and real estate. Banks are more interesting, as investors are clearly digging around for yield plays right now, judging by the rush to get exposure to Reed Elsevier (REL) before the publisher’s 82p special dividend payment on 4 January.

Lloyds TSB (LLOY) may therefore be worth a look, with a prospective PE and yield of around 8 for 2008. However, investors should note in the last recession, UK banking earnings peaked in 1990 and had halved by 1993, taking until 1995 to get back to their prior peak. There must be risk that banking shares are vulnerable to earnings downgrades this year and therefore are not as cheap as they first look.

Shares says:

BUY GlaxoSmithKline Lloyds TSB, Reckitt Benckiser, Reed Elsevier, Sainsbury, Unilever