Comment: Slow and steady to counter volatility

Unnerved by last week’s wild swings in the markets? Bond prices have jumped and shares have plunged. This is my conviction, and I have good reason to hold to it – buy equities, sell bonds.

Bill Jamieson. Picture: Ian Rutherford

Even for long-term investors determined not to be panicked by sharp and volatile swings, the events of recent weeks have been unsettling. The FTSE 100 Index has fallen from its 12 month high of 6,878 in early September to 6,310.29 (as of Friday’s close), down 568 points or 8.3 per cent. The mood over the weekend would have been worse but for a rally on Wall Street on Friday that helped the FTSE stage a 114 point recovery.

There have been persistent concerns for some time that shares in America were over-priced and that a correction was due. This moment of truth kept being delayed with cumulative news of economic recovery and falls in unemployment.

Against this background, it was likely any sign of slowdown would provide the trigger for a sell-off. Sure enough, these signs have emerged: China and the eurozone to the fore, with downgraded IMF forecasts last week. A pronounced fall in the price of oil – down from $116 in the late summer to about $86 provided further impetus.

It was not only equity investors who were shaken. For months institutional investors and hedge funds had been cutting their holdings of bonds, and in some cases short-selling bonds, on the expectation that strengthening recovery would cause central banks to raise interest rates, forcing bond yields to rise in tandem – and the prices of bonds to fall.

The prospect of a growth slowdown, coupled with continuing evidence of subdued inflation, brought a rush to reduce risk exposure and a scramble to close those short positions and buy back into bonds.

Adding to the stampede were hints from the US Federal Reserve that it would put its wind-down of quantitative easing on pause.

Some believe all this is a premonition of a long period of low to no economic growth – How likely is this?

There’s no doubting the evidence of slowdown across the eurozone, and arguably as worrying is the policy gridlock that accompanies this. But those global IMF forecasts were far from uniform. The US was given an upgrade and the forecasts for the UK were kept in place.

The upturn here still has momentum. Bear in mind also that the UK corporate sector is awash with cash.

Second, the fall in the oil price helps to cut business costs and is as good as a tax cut for millions, putting hundreds of pounds back in the pockets of consumers. Third, falling unemployment in the UK and US gives confidence that consumer spending will continue to inch higher while labour market tightening will bring higher pay levels in due course.

Finally, the postponement of a rate rise until well into next year will be a welcome relief for business and homeowners alike. Bank lending to business has been recovering and the prospect of lending rates lower for longer should help business expansion and investment.

For investors, the case for patience and taking the long view has seldom been stronger. While the wild swings of last week are unnerving, those saving for retirement or building a long term portfolio should have well diversified holdings – developed and emerging country equities, defensive as well as growth stocks and a large percentage in bonds. The overall damage should therefore not be as severe as the fall in the FTSE 100.

The latest gyrations have taken many large cap UK shares to a level suggesting stagnant profits ahead. But most commentators – Citigroup for example – are still forecasting a ten per cent rise in global earnings this year and further growth next.

The strongest argument for equities remains yield. Bear in mind that by far the biggest contributor to long-term returns in equity markets comes from rolled-up or re-invested dividends. And it is yield considerations that favour equities over bonds. Today the yield on the FT All Share Index is 3.51 per cent – close to its long-run average – while the ten-year bond yield is down to a 12-month low of 2.2 per cent. And savers will need little reminding of the derisory level of short-term yields – three-month money market rates languish at just 0.58 per cent.

The most sensible way to play this market volatility is not to splurge spare cash into the market on sudden dips but to feed money in over time through regular monthly contributions into a broadly-based equity fund or investment trust. Oh, and roll up the dividend income.