A lack of imagination

“There are more things in heaven and earth, Horatio, than are dreamt of in your philosophy” – Hamlet.

As developed stock markets flirt with post-Lehman highs, the US already having hit a new one, investors willing to take equity risk may be wondering whether they’ve missed the boat. Total returns of roughly 15 per cent year-to-date look big, and indeed exceed the long-term annualised expectations built into our own strategic assumptions. It must be too late to buy – mustn’t it?

Much depends on investors’ time horizons, composure and risk appetite. Advice tailored to financial circumstances and personalities is a cornerstone of our investment philosophy. With several unresolved issues still looming large – Greece’s euro membership, Spain’s potential bailout, the US ‘fiscal cliff’ and China’s slowdown – low composure investors should probably sit on the sidelines here. Renewed volatility would not be a surprise and could be emotionally expensive.

But for investors with moderate-risk appetite, and able to take a view beyond the next few months, this could still be an attractive time to buy developed stocks. Our strategic optimism remains stronger than our tactical caution and the balance of risks has tilted favourably as both the ECB and the Fed have outlined more concrete plans for monetary support. Whether that support is needed or not, it offers investors some inexpensive portfolio insurance. And we still doubt that investors are ‘complacent’: the public debate continues to focus on what can go wrong. Even we have felt compelled to present our strategic conviction these last three years in terms of a “muddle through” scenario. The reality is that potentially extreme outturns are not all tilted downwards. Strategists have shown a collective lack of imagination of late.

European investors worrying about US consumer finances (excessively, in our view) have watched the S&P 500 more than double since its 2009 low. However, it remains inexpensive, even if analysts are too optimistic.

What if US housing and labour markets do continue slowly to recover, and profit forecasts are actually raised, while we take a bungee jump, rather than a fatal fall, from that fiscal cliff (as our CIO argued we could in September’s Compass)? Further above normal returns are quite possible in the coming year or so.

The still tentative sell-off in high quality government bonds – Treasuries, gilts, bunds – also suggests it is not too late to buy stocks. The big institutional flows that would signal a widespread reallocation of assets have not yet occurred, suggesting that a lot of professional investors have also missed the stock market rally and may be looking for opportunities to get involved. When that institutional reallocation does eventually occur, those government bond yields could rise sharply, QE3 or not – as we noted last week.

That could constrain an asset we’ve favoured both strategically and tactically of late, namely high-yield corporate bonds (we restated the case as recently as September’s Compass). They have relatively low duration, but do carry some interest rate risk. Spreads are not yet narrow, but could become so when government yields rise. Their yields are still attractive, but we see little room for more long-term capital appreciation – in marked contrast to developed equities.

Jonathan Dobbin (Jonathan. Dobbin@barclays.com) is head of wealth and investment management NI at Barclays and can be contacted on 90882925. Investing in shares is not for everyone. Their value can fall and you can get back less than you invest. If you are unsure, you should seek independent advice.

Source: irishnews.com