The science of stock picking will be crucial for investors seeking a good return over the next 12 months, writes Alan McChesney.
The road to recovery can be a long and uncertain path - so it's understandable for there to be a tremendous amount of nervous sentiment out in the market.
The behaviour of international markets so far this year reflects that, and we're likely to see many more large swings, up and down.
For the investor, achieving positive returns this year - and possibly next - will be more about careful stock picking than buying and holding the index. Those investing in passive index funds may only see a marginal return, as those who have been fully invested over the past 12 years will attest.
But while certain stocks and many sectors around the world are clearly overvalued as a result of last year's unbelievable rally, which was based on the hope of an almost perfect global economic recovery, there are many equally undervalued and attractive stocks that did not participate.
There are many compelling factors to be positive on certain individual stocks. But the key factor is the mountain of money that remains sitting on the sidelines in cash. Understandably while sentiment is uncertain, the safety of cash, even at such ludicrously low interest rates, remains an attractive alternative for many retail investors who are still solely focused on preserving their capital.
This explains why most of the cash that retreated to the sidelines in late 2008 has remained in cash. At some point investors will need to make some return on that cash and while some of it may go into fixed interest, some will find its way back into higher returning equity investments.
The overriding sentiment of nervousness is understandable - turning points for the global economy always have a tendency to throw up a raft of confusing and conflicting data.
But when we look around the world there are more countries and sectors that are improving rather than weakening or deteriorating. Global industrial production is recovering. And if the "model estimate" from leading global investment research firm Bank Credit Analyst is any indicator then global production will soon be back to normalised levels.
Supporting this improving economic outlook is the continuing supportive monetary policy stance being retained by Central Bankers around the world with interest rates in most of the major economies remaining at historical lows.
Deflationary pressures still remain strong as housing markets remain subdued and the lack of employment growth ensures there is no upward pressure on wages. Even in China there is still no inflation despite the economy growing at more than 10 per cent.
The US remains a very exciting place for the savvy investor. The recent fall in US equity prices ignores the ongoing strong recovery in profits.
Right now, after only two quarters of recovery, US non-financial companies are generating some $970 billion (US$700 billion) in free cash flow, an amount equal to 5 per cent of US GDP.
Even at the depths of the recession, cash flows remained positive, again a reflection of the health of US corporate balance sheets.
Painting an even more compelling picture is the biggest boom in exports in 20 years, helped by what has been a very weak US dollar. While the US dollar has begun to strengthen, exports are still booming - an indication that overall global demand is picking up.
While it is clear that there are good options for the smart investor in the US market, there are also opportunities to be had closer to home in China and Asia.
The Chinese market has been hit very heavily in the first couple of months of the year on the back of the negative sentiment aimed at the property market and the monetary tightening that is occurring on the back of strong growth.
This has had a negative impact on the Asian markets. As growth in the region is likely to remain very robust and equity valuations very attractive, the opportunities that now present themselves are quite compelling.
Even in Europe where all the indicators are far more pessimistic, we can expect, like the US, to see a two-tier market develop. Those stocks that are exposed to the banking sector and property will continue to struggle, but there will always be those companies with global competitive advantages not reflected in their share price.
Now more than ever, savvy stock picking will be the key for any investor.
* Alan McChesney is principal of investment firm New Zealand Assets Management.
