In weeks like the one just seen, the instinctive reaction for pretty much every investor is ‘should we sell?’ though perhaps ‘should we buy?’ would be a better one. One suspects those investors who are asking themselves the latter question will be wealthier over the long term.
Are we going to hell in a handcart? It is a possibility. The credit crunch showed the vulnerability of the global economy and it is difficult – and indeed undesirable – to forget that lesson. A default in Europe has moved from a possibility to a reality. The US is in a mess, indebted to its limits, and losing its credit rating to boot. It is difficult to see how these countries can grow with such a backdrop.
There are signs of a second credit crunch emerging. Investors are increasingly reluctant to trade with European banks because they are wary of their exposure to peripheral European assets. If the banking system closes up again and credit lines stop running smoothly, it could well be a rerun of 2008.
But there are also some positive aspects that investors are apt to forget in these types of markets. First, part of this economic weakness may simply be down to the events in Japan at the start of the year. At the time, economists said it would knock growth yet everyone seems surprised when it actually happens. Japan has already started to put the earthquake behind it and it is possible this weakness will be forgotten by next quarter.
Also, valuations are still, if not cheap, then not particularly expensive – and the starting point in 2007/08 was so much higher. Corporate earnings expectations were more optimistic, valuations were higher. The markets simply had so much further to fall. While it would be foolish to suggest markets could not fall further this year, there is no bullish optimism that needs to work its way out of the system. Equally, equities look better value than a number of other asset classes.
Finally, markets are always a little bit crazy over the holiday season. Thin trading volumes mean a few investors can have a disproportionate influence, creating volatility. When people return to work after the summer break, some perspective may yet be restored to markets.
There are undoubtedly very serious problems in the global economy, but it is not necessarily bad news for every company. The corporate sector is still in reasonable health. The global economic situation does not scream ‘buy’, but then the best time to buy seldom does.
Equity valuations are now at a historic low. The FTSE is yielding 3.7%. This is significatly more than the base rate of 0.5% and 1% over the GILT yield. This means you are being rewarded for holding equities. The right approach is to hold a mixed portfolio, diversified both across and within asset classes. The mix of bonds and equities will depend on the risk tolerances, age, lifestyle and personal investment goals of each individual — not on what is happening in the economy or markets at any one time.
The chart below shows what has happened to MFP portfolios over the last 6 months, it highlights the reason why we hold fixed income within your portfolios – particularly reassuring when the markets are experiencing such flux.
As we have seen, even the supposedly most well informed professional investors struggle to get their timing right. So there is no reason to believe that anyone else can do it either. And just provides further proof, if any were needed, of the wisdom of diversification.