Should they lock in profits and return to the safe haven of cash, take advantage of a dip to invest further funds or simply stay invested in anticipation that equities will resume their climb? Charles Robertson, senior investment manager with Murray Asset Management, provides his top ten tips on riding the stock market “big dipper”.
Keep calm and carry on
The first tip is, to paraphrase Corporal Jones in Dad’s Army, “Don’t panic!” The stock market at times is volatile and the key is to hold your nerve when markets are falling. By its very definition, a rollercoaster ride means that dips in the market will be followed by corresponding uplifts..
Avoid herd mentality
The importance of this cannot be underestimated as it can help you avoid “investment bubbles” or hot sectors, though sometimes this is easier said than done! Right now most commentators are reasonably bullish, advising that equities are the place to be. We are concerned by this, because we agree. There are few signs that equities are overvalued. Currently the price-to-earnings ratio on the FTSE 100 Index is approximately 13x, which is broadly in line with the ten-year average.
Resist the temptation to put too much emphasis on how the stock market is performing from day to day, or even from week to week. If you are constantly reacting to short-term movements and are worried when indices and prices move lower, then you have to ask whether you should be investing in equities at all.
Look on the bright side
Without being over-confident there are positives in the market. While recent dips in values have sparked speculation over the end, or scaling back, of quantitative easing (QE) in both the UK and US, it is unlikely that central banks would turn off the taps too quickly. Also, less emphasis on QE could well be a sign that the economies of both countries are improving and in the US there are encouraging signs in, for example, the housing and employment data.
Time to take profits?
After such a strong run in the stock market this is a temptation, particularly on volatile assets. This will depend on your investment objective, which will be based on individual circumstances and attitude to risk. An investor relatively close to retirement would typically adopt a more cautious stance than someone with 20, 30 or 40 years of their working life remaining.
The rate of interest earned on cash deposits remains minimal and is unlikely to rise any time soon, while the yields on government bonds (gilts) are also at historically low levels. After taking into account inflation and taxation returns are negative. Corporate bonds have been popular in recent years yet it seems unlikely that the significant capital gains delivered will repeated and so the main return to an investor will be the coupon (ie interest payment).
Spread your bets
When building a portfolio of investments avoid (unless you are comfortable with high risk) relying on just one asset class and scenario, eg equities continuing to perform well. A balanced, diversified portfolio should contain a mix of assets such as equities, bonds, hedge funds and property.
Evolution not revolution
It may also be time to think about realigning one’s shares portfolio by reducing exposure to areas of the equity market that look “overvalued”. Opportunities remain in shares which offer a decent dividend yield and have attractive free cash flow characteristics such as Centrica and Glaxosmithkline. Such fine tuning should be considered a normal part of portfolio management rather than regularly implementing sweeping changes to asset class exposure.
What to do with cash?
If you buy in to the theory that the stock market has further to run and accept the risks involved, then “buy the dips”. Alternatively, use a regular monthly savings scheme to build equity exposure.
Look for change
What we are dealing with here is an event, or series of events, that will derail the bull market story and which will cause the stock market to enter a new bear phase. However, right now we do not consider that the possible scaling back, or cessation, of QE is the main threat to the equity bull market. Where we are focusing our attention is on fundamentals including inflation, US and China economic data, bond yields and commodity prices. The time will come when it is appropriate to adopt a more cautious stance towards equities to deal with anticipated market volatility, but we don’t believe this stage has been reached yet.