A Guide To Investment Markets - August 2011
What is Happening
Over the last couple of weeks stock markets around the World have suffered a severe setback in confidence, with most major indices falling back somewhere between 10% and 20% in value. Our own FTSE 100 Index of leading blue chip shares has fallen back almost 16% from recent mini-highs in July this year to 5,068 as at 8th August 2011 whilst the Dow Jones, America’s leading Stock Index, has fallen some 15%. In general terms, it is a widely held view that Markets are guilty of irrationally swinging between sentiments of fear and greed. At present, it is the former sentiment that is holding sway. Although these experiences are undeniably unpleasant, both for you as a valued client and ourselves as financial practitioners (many of us also have pensions and savings), stock market set backs are far from new. Since July 1998, we have had 4 previous setbacks of a similar or greater magnitude and yet within relatively short spaces of time, the longest of which was a little over 2 years, our own FTSE 100 had recovered more or less all of these losses and subsequently went on to trade at higher levels.
Why is it Happening?
Every set back usually has its own unique set of reasons that converge to form a perfect storm. In recent weeks there appear to have been four major concerns which have coalesced into one.
· A slackening or noted slow-down in economic activity in some of the World’s most influential economies, most notably the US and to a lesser extent China and the UK.
· A farcical and near political disaster in America where the warring Republican and Democrat politicians were so opposed that agreement on raising the US debt ceiling (to what is a mind bogglingly huge level) almost resulted in the World’s largest economy not being able to pays its debts and obligations in time.
· A downgrading of the credit worthiness of the USA by the credit agency Standard & Poors.
· Continued and probably justified concern over the level of indebtedness of several European economies, their ability to service these debts and the political will power to impose severe austerity measures in order to bring their national budgets onto a more sustainable footing.
As a whole, these factors have combined to spook and depress markets although a sharp re-bound is not inconceivable should further co-ordinated policy measures such as quantitative easing be announced in key markets.
What does it mean to you?
In the short term, the valuation of your portfolio may disappoint albeit we are confident that for clients who have opted for a more middle of the road or cautious approach to investment, falls will be more moderate when compared to what is currently being experienced in equity markets i.e. the benefit that comes from holding a basket of different asset types such as Cash, Bonds, Absolute Return and, to a lesser extent, equities (please see the chart on the next page). For more aggressive clients, valuations will be volatile for the time being, with sharp falls or rises in value over short time periods likely. Investment remains for the medium to longer term.
How are we Responding?
In truth, a market set back has not been entirely surprising to us and therefore, where the nature of our mandates allow, we have been building up some cash at higher market levels as a form of reserve by which to seek to pick up investments at what we consider to be levels that offer sensible value. Most notably, we have been doing this within our own fund which we are able to include in a good many of our client portfolios. Having built up to almost 21% of the value of this fund in cash, we have in recent days begun to feed this back into equity markets, seeking to pick up bargains on behalf of our clients. We are also continuing to monitor and interview other fund managers whose funds we use, constantly assessing whether the style of the funds we use and the risks that they take are within parameters we feel comfortable with on your behalf. Whilst we can’t stop investment markets falling, there are steps we can take to help dilute the risks and we feel we are steering a sensible middle course in what are presently very stormy waters. We are also continuing to favour sectors or funds that are biased towards themes that give exposure to reasonably dependable levels of business activity such as Healthcare, Utilities (electricity, water etc), Consumer Staples (such as Food Retailers like Tesco) to name several.
The mantra of the past has been to buy when Markets are fearful and to sell when Markets are greedy. This has been one of the most important aspects of successful investing in past crises.
Is the Market Behaving Rationally?
Whilst there are justifiable concerns as to the level of economic activity or growth in the global economy going forward, optimistically this might mean more moderate levels of growth in the future or, more pessimistically, flat levels of economic activity. We do not feel we are heading for a Depression akin to that seen in the 1930’s which, to us, is what Equity markets are implying in their behaviour. So even if economic growth is say 1% or 2% lower than what was previously forecast for major economies such as China and USA, does it justify the near 20% share price fall we have seen in the likes of Astra Zeneca or Royal Dutch Shell – several of the World’s leading companies that in 2010 generated over £7bn and £22bn of profits respectively? Probably not. Moreover, blue chip companies such as Astra Zeneca and Royal Dutch Shell are the staple of many equity related investment funds and provide annual, inflation beating dividends to investors way in excess of what can be obtained from a UK Government Bond.
The table below details how leading asset classes (as measured by the Investment Management Association’s classification of Funds) have performed over the last month;
Can The Past Provide Any Guidance As To The Present? In truth, no it can’t at a fund or company level. However, it can provide a useful guide as to the relative value in investment markets and the relative value of equities compared against the other principal asset class of bonds (fixed interest). Two measures serve as useful indicators. One is the yield (average dividend) of the FTSE All Share. The UK Equity market currently yields 3.7% whilst the redemption yield for a 10 year UK Government Bond is presently 2.7%. In recent generations, when equities have yielded more than Bonds, it has usually been a signal equities are more attractive, triggering buyer support and a rally in Markets. Secondly, the ratio of a company’s share price to its earnings per share (EPS) gives a figure known as the P/e ratio. The long term market average has been a multiple of about 15. It is presently 8.9 for the FTSE All Share. Surely a sign that equities have well and truly been oversold.
