Judging by the calls I receive these days it seems the number one question on everyone’s minds is what should I be investing in next/going forward.
No doubt you will have felt the falls in markets over the past few months, but for those that sat tight will have also recouped much of that fall, but what and where to invest going forward is the $64m question.
World stockmarkets finally woke up to the fact that Covid19 might be a bigger problem than originally anticipated on 19th February (strange coincidence that its called Covid19). I set out below a few of the major stockmarket indicies around the world since 19/02/2020
As you can see, some markets have fared better than others, but some markets were at different stages than others, which demonstrates why diversification is so important to a portfolio. UK & Europe fell the hardest but have since recouped a considerable amount of the fall, having initially lost around 35% but now only around 15%.
I often find it helps to start by taking a bigger picture view of where we are now and then apply your crystal ball view of where you think we are likely to be in the next 5/10 years, this requires you to consider virtually everything that you currently know about everything that you think will affect markets, such as demographics, government & corporate debt, the outlook for future interest rates and inflation rates, short term stories like Brexit, US/China trade deal and longer term changes to the way we live like climate change etc.
It is virtually impossible to predict black swan events that might come along from time to time to derail the status quo like Covid19 or what the next black swan event might be. If this was possible then those clever fund managers in the city would have sold out of travel & hospitality stocks in February, but they didn’t, as no one really saw this coming until it had happened, so they sit tight and wait for time to pass and for the inevitable bounce to happen.
Remember, markets are always forward looking, so they discount a bad year as 2020 is bound to be, and focus on 2021 and 2022, which is why we have seen the markets bounce recently.
The facts as we see it
The last two black swan events (namely the credit crunch & Covid19) have seen huge intervention by the state and central banks, which shows in general that governments around the world are ‘in the words of Mario Draghi’ “prepared to do what it takes” to keep their economies on track and growing. A side effect of this medication of ever higher debt piles on the state has been sustained long term low interest rates and even talk of negative interest rates with inflation seemingly low at the same time. This has meant that money is generally cheap to borrow for governments, companies and individuals. This looks set to continue to be the case several years out from here.
I have long held the belief that many central banks around the world were already holding interest rates artificially lower than they should actually be (pre-Covid19) due to fear that raising them in any meaningful way could dampen spending and economic growth. The only country that tried and failed to raise interest rates was the Fed in the USA and they have since pulled back.
To a large extent not much has changed for those investors that dislike risk. Lower risk investors were always told that they needed to accept some risk if they are to maintain the spending power of their money over the longer term as the margin between inflation and interest rate is the real return for a cash investor, but now with interest rates at virtually zero and inflation at around 0.5%, the margin is relatively insignificant and at these rates it would take decades to really feel the effects of the devaluation in your spending power.
When people say they dislike risk, what they are really saying is that they dislike volatility. These are two different things. Volatility is the up’s and downs of the value of the underlying holding over the course of time that you remain invested and large swings (like those seen in the past few months) scare some people more than others. The media love a bad news story, so tend to highlight dramatic falls on their news bulletins, but rarely do they highlight with the same vigour when markets make a gain of the same amount and this only serves to confirm the actions taken by a risk averse investor to be the correct one. Risk is about the percentage chance you have of achieving an above average return over a given period of time or even a potential loss over that same time. In other words, from point ‘A’ at the start to point ‘B’ at the end.
Let’s look at the bond market: it used to be the case that you could lend your money to the UK government (which is virtually guaranteed to repay your loan at a pre-determined date) via buying a government gilt paying say 7%pa coupon. Nowadays that same gilt will cost you more to buy as the market calculates the future coupon and expected maturity date into the current price, so the price would be what is known as above par. Hence investors are being forced up the risk scale to take on higher risk debt instruments below what is known as investment grade in order to get the coupon they desire at a lower price but still above par.
So if cash and bonds are no place to hide, where else? The obvious answer is equities, but you have to be able to stomach volatility and if you can’t take the volatility then your only option is to stick with cash full-stop. Of course there are some other clever variants like structured deposit products that can potentially offer you a higher return if stock markets achieve a particular return and if they don’t, then you simply get your cash back with no interest, but that could be in 3 or 6 years depending upon the structured deposit product on offer. Some would argue that as long as they get their capital back then that’s fine, as the interest they would have earned in the bank was not worth worrying about anyway.
I could ramble on for ages, so without further ado…….The bottom line is that sitting in cash may not be such a bad thing as long as you can live with or prefer to make a ‘known loss’ of around 0.5% each year with the peace of mind knowing that your loss is limited to this. Move up the risk scale to investing into bonds (both government and corporate debt) but I would suggest via a strategic bond fund or discretionary portfolio service where the fund manager has the flexibility and freedom to buy and sell as he/she see’s fit, and hopefully they can make you some money (after their charges) in the margins i.e. the redemption yield which is the price paid for the bond and the coupon you are expecting to receive.
The two things that concern me about bonds at the moment is the amount of borrowing generally by governments and corporates and probably more likely is any potential for interest rate hikes, albeit seems unlikely at the moment, this could still happen and remember markets are forward looking so would react before the event actually happened, as they would start to price the value of bonds in anticipation of interest rate hikes.
Equities seem to be the only game in town at the moment, but obviously come with risk and volatility, but over the longer term equities should outperform cash and bonds just by their very nature that what you are buying is part of a company and in general that company will sell things and always charge sufficient for it’s product or service to cover its running costs (including servicing of any debt obligations) as well as building in a healthy profit margin. The choice of which sector you invest into will be extremely important as we have seen with Covid19, hospitality has suffered whilst technology has benefitted. Of course if they have increased costs then they tend to increase their price, which then helps drive up inflation which in turn makes it more likely that interest rates would rise to curb the effects of inflation. So in a way equities are kind of inflation proofed. It’s a bit like the ‘circle of life’ and this is why I believe we will never be able to stop boom and bust market scenarios, it’s just the way the markets work, or should I say we all work, as we don’t all stand still and stay the same. Sometimes we carry more debt, sometimes we have more savings, sometimes we earn more and sometimes we earn less.
If you can live with the volatility and stick by a few simple investment behavioural rules then you should be fine. Don’t get greedy, sell when markets are relatively high, you will never pick the top, just like you will never pick the bottom. Resist the temptation to sell when markets are falling. Diversification is your friend, accept that not all investment types will perform the same but they all have a purpose in a well diversified portfolio. Ignore the noise both at distressed times as well as jubilant times. Don’t worry about sitting in cash earning no interest for a while or even a few years if necessary.
Final point – remember, when I talk about holding equities or bonds we are not stockbrokers and so do not recommend specific stocks. We are independent financial advisers and use collectives (i.e. funds) which could be a unit trust, open ended investment company (OEIC), Exchange Traded Fund (ETF) or an investment trust. Each type of collective structure has it’s pro’s & con’s so make sure you contact us for advice before making any investment.
Information contained in this article is purely based on our own personal opinion and should not in any way be mistaken for personalised investment advice that might be applicable to your personal circumstances.