Bill Jamieson: We can’t afford to let the heart rule the head

By BILL JAMIESON
Published on 20/08/2012 00:20

Crisis? What crisis? Across the world, stock markets have continued to rise as if all our woes were yesterday.

In New York, the S&P 500 is grazing a four-year high. Here in the UK, the FTSE-100 has quietly climbed to 5,852.4, having been below 5,400 in June and below 5,000 within the past 12 months.

Arguably the biggest surprise has been Europe. The EuroFirst 300 is up 17 per cent since June. Yields on troubled eurozone sovereign debt have been edging down.

What has happened to the great euro crisis – the ever-imminent expulsion of Greece from the single currency, the coming collapse of Spanish banks, the pending meltdown of Italy? And here at home, has there been a break in the miserable daily litany of recession?

Even that closely-watched “fear gauge” in America – the Vix index – has tumbled to a five-year low of 13.7, down 60 per cent in 12 months.

So what has brought about this strange uplift in mood?

Well, it is August. Trading volumes are down. Many traders, mood-shapers and politicians are on holiday. Investors have continued to take comfort from that firm declaration of European Central Bank governor Mario Draghi that he would do “whatever it takes” to address the euro
crisis and save the single currency.

Markets assume that a splurge of money printing is soon to be unleashed. And, judging by the nods and winks from Ben Bernanke, the US Federal Reserve is also posed to resume quantitative easing. Better-than-expected labour market figures and a modest uptick in consumer confidence have also helped the mood on Wall Street.

So, have market fundamentals changed? Or has nothing really changed that much?

For the past two years, investors have had to contend with stomach-churning rides on the big dipper of global finance. It is as if we were spectators in a theatre and every so often a member of the cast flashed a big card declaring “risk on” – a signal that it is safe to invest – or “risk off” – a signal to remove all your chips from the table.

The resulting volatility in the market has been scary to experience. Close followers of the Vix index warn that a fall below 15 has in the past signalled a renewed burst of turbulence and apprehensive selling.

Many retail investors are not waiting to find out. They have sold up and gone, preferring the more stable if less rewarding theatre of bonds. But there yields have fallen to levels seldom seen for a hundred years or more. This has caused some to warn that bonds may be about to experience the biggest big dipper plunge of them all as central banks seek to inflate their way out of recession.

We know also that the euro crisis is far from resolved. The German Bundestag and the country’s constitutional court are by no means reconciled to a central bank resort to more quantitative easing and an expansion of eurozone bail-out funds.

In America, corporate earnings are trending down. Here in the UK, a toxic combination of debt deleveraging, pressure on household incomes, continuing bank scandals, revolts over executive pay, poor economic data and tighter regulation of insurance company funds have caused an exodus from shares. The number of quoted companies continues to shrink. New issues are the exception, not the rule.

Add to this the dismal performance of shares over the past decade – according to Credit Suisse data, UK shares have delivered real (after inflation) returns of minus 0.7 per cent a year compared with 3.7 per cent from bonds – and it is little wonder that stock market guru Bill Gross propounds the view that “the cult of equity is dying”.

Events over the past three years do give this resonance. But do we really believe that bonds with ultra-low levels of yield exposing investors to inflation are really a safe asset class? And have all equities really performed that badly?

Regular readers will know of my preference for income orientated equity funds and trusts. So I checked on the TrustNet website to see if this advice had been misplaced.

The TrustNet tables show that almost all income-orientated investment trusts are showing a gain over the past year. But it is the performance over the past three volatile “risk-on, risk-off” years that caught my eye.

Of the eight major investment trusts in the Global Growth & Income sector, the average gain over one year is 6.1 per cent and over three years 50 per cent. Murray International Trust is up 77.8 per cent over three years. British Assets Trust is up 43.9 per cent, SAINTs up 60.7 per cent and Securities Trust of Scotland up 77.7 per cent. The yield on these trusts today ranges between 3.8 per cent and 4.99 per cent.

In the UK Growth & Income Sector, there are 23 trusts. The average gain over one year is 12.6 per cent and over three years 47.3 per cent. Among the most popular – and frequently cited in this column – are City of London up 70 per cent over three years; Dunedin Income & Growth up 68.3 per cent, Invesco Income & Growth up 63.5 per cent, Murray Income up 63.1 per cent and Troy Income & Growth up 69 per cent.

I see no reason to change my advice, ditch these trusts for bonds, or even to dash for cash. For investors wary of inflation, a combination of income funds and a sprinkling of gold or gold mining shares looks the best defensive posture for now.