LAST month I looked at the latest developments in the financial markets and asked whether the recent recovery in the markets was a cause for celebration or a reason to worry about a false dawn.
This month I am continuing the investment theme on the basis that the huge summer recovery of UK equities may have put even England’s Ashes-winning cricketers in the shade! The stock market is up more than 40% since its 9th March lows and the prospect of another Great Depression appears to be behind us with the FTSE 100 having broken through the “magical” 5,000 barrier at the time of writing.
Indeed, the speed of the rebound has surprised many and it is difficult to imagine that just five months ago the UK stock market was suffering the market equivalent of a series whitewash. Instead, just as Andrew Strauss’s team got the bit between their teeth to steel themselves for revenge following their 5-0 series defeat in Australia in 2006-07, so the stock market staged a recovery of equally significant proportions!
Classic adage
Those who adhere to the classic investment adage, “Sell in May, go away, buy again on Labour Day”, have had a rude awakening this year! The time-honoured approach is based on a theory that stock market performance from May to September is significantly weaker on average than in other months.
It enjoys both anecdotal and statistical support with research from Standard and Poor suggesting that its flagship S&P 500 Index has performed four times better on average each month from November until April than from May to October.
However, despite the accolades, the “Sell in May” approach looks set to suffer an embarrassing 2009. The FTSE 100 and S&P 500 Indices are up around 20% since May and (unless we see a spectacular autumn) it looks unlikely that the maxim will hold true. Perhaps more realistically, it may be time to start re-thinking some of our beloved investment idioms.
One such investment proverb that may require re-evaluation is “beware the dead cat bounce”. This slightly macabre phrase is used to depict a false rally, just as a dead cat might bounce if you tossed it from a building! It is often used to explain the 6-7% rally that came just two days after the October 1987 crash. That rebound turned out to be short-lived and added to the expression’s standing.
Events in 2009, however, appear to diminish its relevance. The market recovery since 9th March has confounded skepticism and repeated warnings of false dawns to go on and deliver sustained returns through to September, leaving those who were waiting for a correction to miss out on the rally.
There are other investment sayings, many of them seasonal, that will be tested over the coming months. A Thanksgiving rally, a December sell-off, and a January effect in growth stocks have consistently featured in the investment calendar. However, with markets continuing to buck expectations, investors may be wise to tread more carefully when following the unwritten rulebook of investing.
The recent rally in the FTSE 100 index may yet prove to be enduring, though it did stumble for a moment, and the reasons advanced for this are typically as varied as the commentators who offered them! Maybe it got ahead of itself and was heading for a “dead cat bounce”, but it seems more likely that a spell of profit-taking – and a pause for breath – lay behind the hiccup.
This is not to say that it is too soon for investors to contemplate a return to the upper echelons of the equity market. Plenty of fund managers are doing just that as there is a view that prices have dropped pretty much as far as they are going to, and it is those who adapt earlier who stand to gain most.
Opportunities
If we accept this proposition, the investment world out there is ripe with opportunity for both value- and growth-driven investment philosophies.
In the aftermath of the stockmarket meltdown, most of the bad news has been priced into stocks, with little distinction between the unloved value candidates and the growth stalwarts of the blue-chip index. There comes a point at which the difference between value- and growth-driven investment becomes insignificant, and that is where the markets sit now.
So, as the global economic recession comes to an end, and markets begin to price in a return to positive, if muted, profits growth into 2010, investors are starting to lengthen their time horizons and consider how to re-balance their portfolios.
We still need to warn clients that the recovery from this recession will not be normal by previous standards. There are a variety of issues, whether it be debt management, a tightening in fiscal policy or economic re-balancing, which suggest that the economic upturn will be more subdued.
Nevertheless, it would appear as though things are slowly returning to some form of normality, with France. Germany and Japan announcing that they are out of recession and a series of reports indicating that the UK won’t now be too far behind. A further positive is that there remains a substantial amount of funding on the sidelines.
High cash levels
Cash levels have remained high and there is a greater capacity for fund inflows into UK equities as investor risk-appetite continues to increase over the coming months.
However, the room for upside does come with a warning. With valuations across the market relatively even, it would appear as though a “rising tide” effect has brought us this far. A continuation in positive returns will require a greater need for appropriate stock selection and a deeper understanding of the winners and losers of this recovery.
A relevant question for investors, therefore, is to now ask what sort of returns they can look forward to over the coming decade if they invest at current levels? Past history is helpful, but can be misleading. After all, a recent study from Barclays calculated that since 1900 UK equities have earned an average 4.9% a year in real terms, outperforming fixed interest bonds and cash by 3.7% and 3.9% respectively.
More recently though, relative returns have been very different as equities have suffered two bear markets since 2000. Investors have been harshly reminded that their compensation for taking on risk is not guaranteed even over as long a period as a decade.
Asset selection historically has suggested equities have been the asset of choice relative to government bonds and cash over the last 100 years as investors have been compensated for holding equities with a high-risk premium.
Our approach is to advocate that a more diversified portfolio should be attractive in the future. This is because projected asset returns over the next decade indicate that equities should not necessarily be favoured on a yield-plus-growth valuation basis, as other assets such as corporate bonds offer compelling value and an elevated risk premium.
A key point is that the difference in performance between asset classes is set to be narrower, reflecting the fact that the structural falls in inflation and interest rates, which were major drivers of returns in the 1980s and 1990s, have come to an end. Meanwhile, the outlook for global economic growth and thus corporate cash flow is less dynamic than has been seen historically.
For all these reasons, we therefore suggest that the nominal returns on assets that compensate investors for inflation, such as equities, will be lower in the future.
In conclusion, yield looks set to be a larger component of overall returns whilst diversifying your investments across equities, bonds/fixed interest and cash, as well as across a number of world markets, can help lower your overall level of investment risk.
This may make for a less bumpy ride as we emerge from the crippling recession and look forward to 2010 with renewed optimism.
■ The author can be contacted at: Allchurch Bailey Wealth, 93 High Street, Evesham, Worcs. WR11 4DU; telephone 01386 442597, email andrew.neale@abwealth.co.uk; website www.abwealth.co.uk.fin
