Out of a clear blue sky, what could possibly disturb the sanguinity of stock markets at this time? Central banks are in accommodative mode; loose money keeps on flowing; economic data and business surveys continue to point upwards; inflation is subdued.
But cracks are already forming. And worryingly, they are forming at the top among the world’s leading central banks. Central bank policy in both the US and UK is now in confusion as to whether we should pursue tapering and policy tightening or keep interest rates lower for longer. And the wheels are coming off forward guidance.
For investors, it would be wise to prepare for turbulence ahead. Despite defensive trusts having trailed the stock market over the past 12 months, this may well be the time to stay defensive as the stakes are raised on a policy gamble against inflation. Yesteryear’s laggards may well prove this year’s safer havens. And I would not rule out putting a modest amount in gold-related funds at this time.
So, where are those cracks, exactly? Barely a month ago, the US Federal Reserve declared it would begin “tapering” its programme of bond purchases – the second such signal to markets. It has also said it will maintain low interest rates for some time after unemployment falls below 6.5 per cent. But the latest slowdown in employment data has rekindled doubts as to when tapering will begin. Monument Securities economist Stephen Lewis said tartly that the Fed’s communications are in “shambles”.
Similar confusion has descended over forward guidance policy at the Bank of England, which said in August that it would consider a rate rise when unemployment fell to 7 per cent.
With the jobless rate having fallen faster than expected to 7.4 per cent, the market is left to ponder whether borrowing costs will rise in the next 12 months, or if the Bank’s guidance will change. What confidence could there be that even a lower trigger point would be lowered still further?
Central banks appear no clearer in reading the runes than the rest of us are. It is this uncertainty that could provide a jolt to confidence in the months ahead. And that could see some of the optimistic froth being blown from equity market valuations.
According to Psigma fund manager Thomas Becket, investors should expect a 15 per cent correction in global stock markets this year. Helped by unconventional intervention such as quantitative easing and ultra-loose interest rates, markets have been on an upward trend over the past five years.
He said: “If there is any disappointment, be it economic or other, company share prices will be punished.
“Do I think we will see the last five years’ returns over the next five years? Absolutely not.”
That will strike defensive investors as particularly dismal, as some of the market’s giant cautious funds have underperformed over the past 12 months, among them M&G Recovery, Aberdeen Emerging Markets Equity, Newton Global Higher Income and Trojan Income. According to TrustNet, 60 £1 billion-plus funds significantly underperformed their peer group last year.
Funds prioritising capital protection that have a natural bias towards defensive stocks fell short of their sector average in a year in which cyclical sectors rallied. But in the event of a market jolt, these are just the funds likely to provide relative protection as 2013’s high-fliers succumb to profit-taking.
And there is an argument for investors to look to last year’s notably poor performers – gold bullion and gold miners – to hedge their portfolios against a market sell-off.
Mark Harris, head of multi-asset funds at City Financial, said last week that investors should prepare for volatility in equities over the next six to 12 months. For this reason he is buying gold and gold miners as protection.
When central banks are seen to lose their footing – as 2014 may well expose – gold may act, as it has historically, as a cushion against monetary policy instability.