WHAT goes around, comes around. And today the world is presenting an all too familiar mystery: how is it that, with so much bad news and fretting about a return to recession, the stock market has been enjoying one of its strongest rallies in years?
Last week the FTSE 100 climbed 130 points, or 2.1 per cent, to 6,284.45. This takes the index’s gain since the start of the month to 6 per cent – and over the past six months, to 15 per cent.
Back then, of course, the headlines were dominated by fears of a massive eurozone crisis, a domino-style series of bank collapses and the return of a global financial crisis – feared to be worse than 2008-09.
How can sentiment have changed so quickly? And after such a steep and speedy rise, is the stock market now vulnerable to a setback?
I listed here last week some of the reasons behind the stark change in sentiment: signs of recovery in the US, particularly in the housing market; reassuring news on the direction of China’s economy; and evidence of improved confidence in the eurozone – or at least a step back from the precipice. That’s not at all the same thing as recovery, but is a vital pre-condition of a return of financial and business confidence.
To this list I would add the stream of better-than-expected profits from companies as varied as Ikea and Unilever. Employment data in the UK continues to improve, with the highest number of people in work since current records began in 1971. And there is sufficient evidence to suggest that the Funding for Lending scheme is now boosting the supply of mortgages, with approvals hitting an 11-month high in December.
The broad picture emerging across the world is of economies moving towards recovery. The UK may be well back in the field, with little sign of a recovery on the horizon. But there is the prospect that, in due course, this incoming tide will lift all the boats.
It is this improved sentiment – even if there is very little hard and fast evidence to back it up – that accounts for the strength of the FTSE 100. One “resistance level” after another has fallen – first 6,000, then 6,100, then 6,200. Now there are predictions 6,400 will be the next hurdle to fall.
But it is not just the FTSE 100 behemoths that have surged. The smaller company indices have also been hitting new highs. A quick flick through the top ten performing investment trusts over the past 12 months shows how funds specialising in this area have done outstandingly well.
Thus, any well-diversified individual savings account (Isa) or pension fund equity portfolio should be looking rosier than was the case six months ago. And there is little doubt that, as this rally has continued, more investors have been tempted to switch out of bonds – the favoured asset class of the past four years – into equities in the hope that, at long last, equities may be regaining their appeal as the asset class most likely to deliver a superior return.
However, after such a strong run it is increasingly likely that a correction will set in. Rallies rarely proceed for long in linear fashion, in an unbroken straight line, but rather come in jagged waves. Previous upturns show a broad upward movement over time, but the progression is pockmarked by setbacks and corrections.
I cannot see how the period ahead should be any different. The difficulty for investors, as always, is how to cope with such fluctuations. I have never been a great fan of the “cautious managed” fund sector. Within this definition is a wide variation of investment selection and approach, and it always pays to look at the underlying portfolio. “Cautious managed” should be more than an index-tracker fund with a few corporate bond and index-linked gilts.
Within the equity portfolio itself should be well-established defensive stocks with a good dividend-paying record and with holdings spread across different market sectors and geographic areas. Rather than chase equity funds that have led the pack over the past few months with impressive gains, it is the more cautious funds I would be looking towards. They tend on the whole to put in a stronger relative performance when the market overall looks set for a “correction”.
Another favoured tactic is, of course, regular monthly investment. Far too often investment in Isas disappoints because a lump sum has been committed after a sharp rise in the market, and when confidence and expectation are at their highest. Many investors doom themselves to bad timing by leaving their Isa investment until the final month of the tax year.
Back in March, investors may have had little appetite for shares and opted instead for a choice of bond funds or a cash Isa. They have now missed out on the best market rally in recent years.
But the investor who took out a 2012-13 Isa at the start of the tax year and opted to feed in the £11,280 Isa maximum in monthly instalments of £940 would now be looking at a very healthy capital growth indeed by pursuing this cautious strategy.