IN BRITAIN and America, stock markets graze all-time highs. Interest rate rises loom on the horizon. And after a 57 per cent rise in the FTSE 100 over the past five years, a market correction looks ever more likely. Investors are finding shares expensive. Yet still a warm wind blows and the stately galleons of the bull market sail on.
This is a testing time. While the FTSE 100 – up another 0.2 per cent last week to 6,858.21 – looks set to break new highs, the mid-cap FTSE 250 is on a price-earnings ratio of almost 20. And across investment trusts – my favourite sector – many share prices are now standing on a premium to their underlying assets.
Investors have an uneasy feeling that they are being priced out of the market, and not just for equities. As Morningstar’s Emma Wall points out, the same is true of the bond market.
For the past 12 months the consensus mantra has been that we have seen the top of the market for government stocks and bonds. With central banks signalling an end to the emergency policy of quantitative easing (QE) and that record low interest rates would not last for ever, it seemed there would be a bond market sell-off. Yet the pundits have been confounded. The yield on US government bonds has continued to fall and bonds are more expensive than six months ago.
So what has been driving bonds higher? The culprit was severe weather, and its impact on the US economy and corporate earnings in the first quarter. Bonds swung back in favour, despite the cutbacks in the Federal Reserve’s QE support.
The argument for a pull-out from bonds is even more potent now, particularly in the wake of last week’s buoyant US job numbers. But shares are not looking at all cheap. After one of the strongest bull markets on record, Tom Becket, chief investment officer of Psigma, says the ripe, low-hanging fruit have all been picked.
And Marcus Brookes, multi-asset manager at Schroders, fully agrees. He says the market is so short of high-conviction ideas that the Schroder MM Diversity Tactical Fund has now built up a cash position of 45 per cent. “According to our analysis, both bonds and equities are due a correction over the next year,” he says.
These assessments are understandably unsettling for investors and many may be tempted to take profits while they can. But we need to remind ourselves of the time horizon of our investment aims and the benefits of income accumulation and re-investment over the medium to long term.
The main reason for not selling, said Money Week’s digital managing editor Ed Bowsher last week, “is that I’m a long-term investor”.
He added: “I’m investing to fund my retirement in 20 years’ time, so what happens to my portfolio over the next couple of years doesn’t matter hugely. All the matters is what my portfolio is worth in the 2030s and later.”
Playing the market – selling now with a view to buying back later at lower levels – can be a high-risk strategy and market timing is a skill hard to acquire. Markets, Bowsher reminds us, “have a well-documented tendency to ‘overshoot’ in the good times, as well as ‘undershoot’ in the bad times”. And they don’t always tumble to order when appearing over-valued.
It’s possible, he says, for the FTSE 100 to be range-bound – say between 6,500 and 7,000 over the next two years. “If that happens, you might think there’s no great need to be invested in the stock market over that period. But you’d be wrong, because you’d be missing out on a nice dividend income.
“The FTSE 100 is paying a 3.3 per cent dividend yield, well ahead of gilts or a savings account. And, of course, even if share prices in the FTSE don’t rise in the near future, you can be still be fairly confident that the overall dividend payout will continue to go up. Dividends comprise a large chunk of long-term stock market returns, so why not just stay invested and keep the dividends?”
An excellent point, and one which underpins the case for drip-feeding money over a sustained period. As for searching for value, investors could do worse than consider trusts specialising in markets in north Asia – including Japan – peripheral Europe and certain emerging markets such as Brazil.
And in the UK there is a wide value disparity between sectors. According to Threadneedle head of UK equities Simon Brazier, retail and consumer services stocks are the most expensive, while oil producers, food retailers and pharmaceuticals are all cheap.
For now, the advice is to keep an eye out for value rather than opt for a generalist, index-hugging trust and have cash ready to take advantage of opportunities.