Ken Taylor: Encouraging start to year for investors in spite of Europe’s woes

As predicted, inflation has fallen further and should continue downwards for some time yet. This, in turn, will ensure interest rates remain at current levels well into next year.

So suddenly all is well with the world… or is it?

Without in any way wishing to appear negative, it is surely worth remembering that little of the fundamentals have changed. Greece still represents a rather large elephant in the room, and the potential for a domino effect resulting from their departure from the euro is very real. Last year’s extreme gyrations in markets were largely explained by political forces being dominant, yet these same dynamics remain extremely prevalent and markets are now rising.

The recent strong run in markets can to some extent be explained by investors finally accepting that in order to generate a real return on their capital, they need to be looking beyond deposit accounts.

While it is easy to criticise, and with the benefit of hindsight be dismissive of why it has taken so long for people to come to this conclusion, it remains something of a constant in terms of human behaviour. Time and again, too many people sell near the bottom of a cycle and are late to return when things look more favourable.

I might be wrong, but I am of the opinion that just as the fall-out from the 2008 financial crisis has been both deeper and longer-lasting than most people imagined, the recovery in markets might be more prolonged than is typically the case.

In other words, while it is perhaps difficult to convince yourself that you have not (once again) missed the boat, markets might just have a lot further to run from here. This is certainly a view that is beginning to emerge from a number of sources, including some fund managers who have been around long enough to be worthy of your attention.

The one thing that will be guaranteed is that any rise from current levels will not be without some possibly severe bumps along the way, but beyond the next six months or so we might well be looking at a significant bull market phase. All the usual caveats apply, but it is becoming increasingly clear that investors’ appetite for risk is returning.

For individuals considering their options, I would suggest that some basic principles apply. Firstly, when stock markets are rising you should participate. Nobody gets market timing absolutely right other than by luck alone, but if you are minded to believe that historically low interest rates, falling inflation and relatively cheap valuations are all prevalent, then it is likely that stock markets will rise.

Secondly, investors need to be responsive to change. Recent years have served to remind us all that markets can fall as quickly as they rise, and hence being realistic in terms of anticipated returns is vital. It is very difficult to accept or realise a loss on an investment, but in my experience it is equally difficult to persuade an investor to take a profit. It might be corny, but there is no profit until it is realised.

Thirdly, diversification remains essential. Just because a headline index rises, it does not follow that every share within the index goes up.

To be successful requires a little bit more than simply investing a lump sum, especially if it is applied to a single choice of company or fund. Allied to this, consider the cost of being wrong. Diversifying beyond a single asset class can provide a significant degree of protection from market falls.

In summary, this is an ideal time for investors to be considering their options.

We unquestionably live in volatile times, but appreciating that the backdrop remains one of falling inflation, negative real interest rates and modest economic growth should lead to the conclusion that there are after all some grounds for optimism.

• Ken Taylor is managing director of Mackenzie Taylor Wealth Management