With the FTSE 100 index having fallen back below 7,000, bond and currency markets volatile and worries about Greece filling the headlines, private investors appear wary of financial markets.
In fact, investors who have been prepared to take on a bit of old fashioned risk are doing nicely this year; global equities have returned nearly 5 per cent and the UK’s All Share index over 7 per cent (atr the time of writing).
Performance of indices over 2015
Source: FE Analytics
In a world of near zero interest rates and inflation, that represents a generous real return which most of us would be happy to see doubled for the year as a whole.
For the risk averse, it has not been so comfortable. The Citigroup World Government Bond index has returned -5 per cent; not an investment disaster but an unpleasant surprise for those who thought that an uncertain world required a cautious approach.
Performance of index over 2015
Source: FE Analytics
Conventional wisdom is being turned on its head. The bull market in equities is now more than six years old and the business cycle not much less. This is already one of the longest periods of business expansion in history while the equity market has not had a significant setback since 2011. Naturally, investors are wondering how long this can continue.
The answer, we think, is for quite a while. Economic growth has been more moderate than in previous cycles and there is no sign of the over-heating usually seen late in the cycle when credit growth is booming, inflation picking up and growth accelerating.
Equity market ratings have not been driven above the long term historic average, despite unusually low interest rates and bond yields, there is no excess of optimism and no rush of money into the market. The gloom of six years ago has dissipated but the euphoria normally seen at market tops is notably absent.
We believe the second half of 2015 and 2016 offer more of the same; steady economic growth, continuing low inflation and a pick-up in the rate of growth of corporate earnings.
This would improve the valuation of equities in response to which markets will probably rise steadily. Bond yields could drift higher but the first half’s performance looks more like a retreat from overvaluation than the start of a sustained bear market.
There will be plenty of macro-economic worries; after all Thomas Carlyle did call it the “dismal science.” Geo-political issues would dominate the media but investors should remember Arthur Balfour’s perhaps exaggerated observation that “nothing matters very much and few things matter at all.”
We think it will be far more rewarding for investors to spend their time and energy seeking out the increasingly abundant opportunities to add value from stock and credit selection. This is already a very good year for stock and theme selection and the future should offer more of the same.
Those who are hoping for double-digit returns, however, are likely to be disappointed. In an era of secular moderation, we think investors can expect long cycles with only mild downturns, a muted interest rate cycle and, for as long as investors remain cautious, modest returns.
With low inflation, upper single-digit returns for equities and lower single-digit returns for government bonds should be the norm. This is a market for patient long-term investors, not for get-rich-quick traders or the greedy.
Max King is portfolio manager on the Investec Multi Asset Protector fund. The views expressed above are his own and should not be taken as investment advice.
