In the latest issue of Vogue magazine, there is an article about the correlation between skirt hemlines and financial markets. When markets ride high, the article suggests, the miniskirt reigns supreme, and as the FTSE tanks, women become fans of full length.
Expensive stocks have become more so, forcing investors to talk of relative valuations
The comparison may seem a frivolous start to what promises to be a far more intellectual discussion, but skirt lengths may prove as reliable a crystal ball as any in our current climate.
2016 rather made a mockery of forecasters. If you had correctly called the political outcomes – Brexit, a new UK Prime Minister and Trump in the White House – it is highly doubtful you would have correctly called the stock market’s reaction. Project Fear’s worst nightmare came to pass and instead of recession and a global financial crisis, so far we’ve been rewarded with stock market highs on both sides of the pond.
As a result, expensive assets have become more so, forcing asset allocators to talk of relative valuations, rather than historical ones. Stocks may be pricey, but look at bonds. European equities may have rallied, but compare them to their US counterparts. Is this simply clutching at straws or can investors find quality securities at a reasonable prices in the current market place? Is it enough to invest in in these relatively cheap assets or to make money in today’s world do you have to bet against the market?
Valuation is not the only concern for retail investors; the clamour for income remains as loud as ever. After seven years of record low interest rates, Bank of England base rate fell even further to 0.25% in 2016, and government bonds remain frustratingly low. While we may not be in the negative territory of some of our European counterparts, rising inflation is nipping at investor’s heels. On the latest figures, the UK Consumer Price Index at 1.6% is higher than 10-year gilt yield at 1.47%. In Germany, the figures are considerably more bleak – inflation is up to 1.7%, while the 10-year bund yields just 0.5%.
In the UK, the promise of pension freedoms has exacerbated the issue, as over-55s, freed from compulsory annuity purchase, look for a way to make their retirement pots replace a regular wage.
Negotiating Market Risks
We head into 2017 with much uncertainty – the spectre of Trump looms, as too does the threat of political upset in Europe. Inflation looks set to go higher, which in turn could mean higher interest rates and commodity prices could go either way. So how do you make investment decisions faced with such headwinds?
Long-term investors should try to ride out the volatility, but for those who have to make investment decisions there are key questions to face.
Investec’s co-head of multi-asset growth Philip Saunders said that it was not necessarily the political headlines that investors should be focusing on in 2017. Instead, he suggests that monetary policy – or lack thereof – will be the bigger driver of markets this year. He says that European elections this year may cause volatility but the bigger investor story for the region is what the European Central Bank does with interest rates and quantitative easing. He believes a higher rate of inflation is coming, and this will mean the ECB faces pressure to raise rates.
“When we first outlined our predictions for 2017 it was October and the idea that the developed world would face a higher rate of inflation was contrarian,” he said. “Now it is the consensus view and already priced into the market.”
His colleague John Stopford, head of multi-asset income for Investec said that it was a challenge finding income-paying assets against that backdrop.
“Safe asset continue to offer little in the way of yield,” he said. “To earn income, investors need to be prepared to take on more risk. Many yielding assets have benefited from a search for yield and now are vulnerable to high inflation and rising interest rates.”
Stopford said he recently been adding global financial stocks as banks – especially those in the Nordic countries and the US – had books that now looked healthy enough to pay a sustainable dividend. He has also increased his exposure to industrial stocks over the past six months.
Michael Spinks, co-head of multi-asset growth for Investec adds that diversification is key to finding growth in such a low-growth, low-yield environment – as too are the use of options. These are bets placed on the market, or individual securities, that they will fall in value, essential in a financial world where so many assets look expensive. Spinks recognises that challenge of meeting his aim or inflation plus 5 percentage points, and plays off parts of the market against one another – betting in October for example that US financial stocks would outperform US utilities stocks. The team made more than 20% on the bet in less than six weeks.
Stopford says: “The key is to be prepared for the worst case scenario. We have a meeting every month when we discuss what could happen in the next 12 months; China, EU elections, oil and trade policy.”
