Bill Jamieson: Be prepared for rocky road ahead

Bill Jamieson. Picture: Ian Rutherford
Bill Jamieson. Picture: Ian Rutherford
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AFTER a five-year rising run on stock markets fuelled by unprecedented resort to monetary easing, clouds have started to gather.

Geo-political tensions have risen sharply in recent weeks; news dominated by Russian military intervention in Ukraine and a bloody Israeli-Arab conflict at the top of concerns over growing instability across the Middle East.

But the main worry for markets, both here and in the US, are growing signs that interest rates are set for a rise. Exactly when seems less important to investors than a general desire to take cover. In New York, the S&P 500 index fell just over three per cent last week, while in London the FTSE 100 lost 1.65 per cent.

That this urge for shelter has been strengthened by the latest figures showing further improvement in US economic performance may be a paradox for many. Last Friday brought news that US non-farm payrolls, a key measure of the labour market, rose a further 209,000 last month – the sixth successive increase of more than 200,000. Manufacturing activity has risen to its highest in more than three years and data earlier last week showed the US economy rebounding by a stronger-than-forecast four per cent in the second quarter.

All this, of course, is portends well for company earnings and expansion in time. But shares on Wall Street have all but discounted this and are fully valued.

However, a prolonged period of rock-bottom interest rates and unprecedented money pumping is drawing to a close.

The concern is that when these props are removed, there will be a sharp correction. Dearer money will bear down on household borrowing and spending as well as business investment and expansion plans. The result is likely to be a slowing in the pace of growth next year.

Fredrik Nerbrand, global head of asset allocation at HSBC, said he “would not be surprised” to see a 10-to-15 per cent fall in shares in the months ahead.

Seasoned market watchers believe such a correction to be long overdue and that banks still have chronic levels of non-performing loans.

So when might the Fed make a move? Chairwoman Janet Yellen has said that “low rates are needed to keep unemployment falling”. But the US jobless rate is already declining towards 6 per cent. Bear in mind, too, that unemployment has long been regarded a “lagging” indicator and that central banks earn their spurs by acting to prevent inflation from taking hold.

Such are the concerns that have caused some investors to suspect that a rate change may come towards the end of this year rather than the first quarter of 2015.

If this has sent the amber lights flashing over share values, it has set off loud alarm bells over bonds. Rising interest rates threaten to lower the price of bonds, forcing up yields. Bond investors are anxious not to be caught out

A scramble will intensify for “safe haven” assets. But in such conditions, what exactly is “safe” and where are they to be found?

In these conditions it makes sense, as I discussed in the context of Personal Assets Trust last week, for investors to increase their cash holdings and wait for the correction to run its course.

And while cautious savers can at last expect to see a better return on their fixed interest holdings, many long-term investors will be reluctant to disturb balanced portfolios and will still be looking to equities to provide capital and income appreciation over time.

One effect of the expected hike in US interest rates has been a rise in the dollar, benefitting those UK companies with a high proportion of their earnings in dollars. And for the brave there is Japan, which is still pushing through growth-orientated policies to haul the country out of a long period of low growth while the rest of Asia has boomed.