Bill Jamieson: Scared bears dip a toe into equities

Bill Jamieson

Bill Jamieson

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In STOCK market fable, great rallies in share prices are led by a charge of rampant buying “bulls” who put sellers of shares (the “bears”) to flight.

Looking at the rally in share prices over the past 12 months, and the 10 per cent surge since the start of the year, we are by all accounts in the early stages of a bull market.

Only this time it’s different. This is not a market made by charging bulls. Instead it is led by “scared bears”: ­apprehensive investors who have ­little conviction that Western econ­omies and their financial markets have turned decisively for the better, but who do not want to be left out of the marked rise in share prices.

Over the past few months the rally has been hailed as the onset of a great rotation: a defining shift in investment preference away from fixed-interest bonds into “defensive” dividend-attractive equities, then out of these defensive holdings into cyclical growth stocks that stand to benefit from an upturn in economic activity.

The stirring advance by America’s Standard & Poor’s 500 Index last week to move above its pre-crash closing high in 2007 to an all-time record is seen as evidence of this seismic shift.

At each stage in this rotation, the risk gauge rises. Growing investor confidence is accompanied by a greater optimism about the earnings prospects for companies. Thus, even though the market is markedly higher than a year ago, investors calculate that shares look cheap. US shares are seen to be offering superior prospective returns compared to historically low yields on bonds.

This great rotation is no academic construct but a fiery wheel on which today’s private investors feel themselves trapped.

Do we stick with the “safe” choice of cash ISAs for the 2013-14 tax year? Do we opt for a “defensive” income unit or investment trust, which may lag the stock market high-growth sectors but tend to be less volatile and offers the cushion of higher than average dividend payments? Or do we opt to “get ahead of the curve” and go all-out for growth – opting for funds and trusts specialising, for example, in smaller companies, or high-growth but high-risk sectors?

For the moment, the UK’s stock market rally has I believe been led by scared bears. And I ‘fess up to being one of them.

In the next few weeks I have to make choices about my regular monthly ISA savings for the 2013-14 tax year. For the year just ending, I have had a very successful run, spreading my monthly £940 across five defensive income-orientated and geographically diversified investment trusts. They include Aberdeen Smaller Companies High Income, Henderson Euro Trust and Henderson Far East Income Trust.

I have no desire to change these investments – but equally I have no desire to “double up” with continued purchases in the new tax year. So I am looking for a fresh batch of funds. But how far up the risk continuum am I prepared to go?

Like many investors, I see little reason to be bullish about stock markets but recoil from the continuing erosion by inflation of ultra-low investment returns on bonds. Equally, I do not want to be out of the equity market, even if I see little by way of conviction behind the immediate investment case.

There is little hope of a strong recovery in the forseeable future. The market looks vulnerable to setback and correction. And in recent weeks the risk of financial turbulence across the eurozone has returned, with Cyprus and now Italy the flashpoints. Renewed instability here would rule out any early recovery of the eurozone from recession as well as dealing a wounding blow to confidence here. So who could be a conviction investor against such a background?

Melanie Mitchell, manager of the £1.4 billion Kames High Yield Bond fund, says fundamentals do not support the current rally and has added her name to the growing list of experts predicting a sharp correction.

She warns that “investors who rush into risk assets and ignore the current poor economic fundamentals will find themselves in a mess” by the end of the year. She confesses herself baffled as to why market sentiment is so high, as she does not see any support in fundamentals for the rally. Because of this she is maintaining a relatively defensive portfolio.

The challenge for me is to choose a five-way split of trusts and funds for regular monthly contribution. I pay keen attention to portfolio diversification, both geographically and by investment sector. And while a few weeks ago I was open-minded as to income and prepared to accept funds yielding less than the FTSE All-Share Average, I have more recently swung back to a more defensive (and higher yielding) short-list. I will be reviewing my 2012-13 ISA investment performance next week, and setting out my final selections for 2013-14.

The key point for me is always to maintain a medium-term (five- to seven-year) investment horizon and to roll up dividend income for re-­investment. The bleak outlook currently is dispiriting. But equity investment is for the longer term and it is on this time-scale that decisions should be taken and performance judged. And in the meantime we have good reason to be scared bears; there is no shame in being one.

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