The danger of a crash landing in high-flying stocks, bonds and property
Global stock markets are flying. In the US, the Dow Jones has shot past its all-time high to trade at more than 20,000. The UK’s FTSE 100 is also breaking records, having burst convincingly through the 7,000 barrier after years of trying.
Bonds are now in a bull market that has lasted more than 30 years and have constantly shrugged off dire warnings of a meltdown.
Property prices continue to power upwards as well, rising another 5.3 per cent over the past 12 months, at their fastest rate for two years, according to the latest Knight Frank Global House Price Index.
Nothing seems able to stop the global surge in asset prices, which has also driven the price of many commodities, including industrial metals and in recent weeks, oil and gas.
Investors have shrugged off war in the Middle East, the Chinese property and credit bubble, euro-zone stagnation, Brexit and the US president Donald Trump, as they continue to drive assets higher and higher.
So why isn’t everybody celebrating? Instead of throwing a party, many investors are watching events nervously, seemingly waiting for everything to go wrong.
Some are more nervous than others. Fund manager David Coombs, head of multi-asset at Rathbone Unit Trust Management, says markets are brewing up a perfect storm, and conditions are ripe for an imminent market correction of at least 10 per cent. It could be more.
He is now holding the highest-ever cash weightings across his portfolios, despite record low interest rates because he saw danger almost everywhere else, according to a report on FT Trustnet.
Mr Coombs isn’t just worried about stock markets falling, he is struggling to find worthwhile investment opportunities across just about every asset class. “We dislike bonds, we dislike property, we dislike infrastructure, we are looking at commodities but they’ve had a bit of a rally. We don’t even like any of the alternative asset classes to be honest. It is really tough at the moment,” he says.
Mr Coombs has a strong investment track record. Since launch in 2009, Rathbone Total Return Portfolio has returned 58.65 per cent compared to its benchmark’s return of 23.92 per cent.
So can stock markets, bonds and property really all crash at the same time? If so, how can investors protect themselves?
Plenty of other analysts also believe that stock markets are overvalued. Josh Mahoney, a market analyst at online trading platform IG, which has offices in the UAE, says a rising gold price is a traditional sign of danger ahead, and it has recently spiked to a three-month high at around $1,240, suggesting the flight to safety may have already begun. “The outperformance of gold, alongside lower-risk bonds and safe currency haven the Japanese yen highlights the worries rumbling beneath global markets.
He suggests the “ominous quiet” across US markets may be a signal that something big is on its way. “The current flows into gold and US Treasuries and away from the S&P 500 is another indication that the equity rally is looking exhausted.”
Kathleen Brooks, research director at City Index Direct, says political dangers are growing, with elections in the Netherlands, France and Germany, where populists could make further headway, Brexit worries and a potential flaring up of the Greek debt and Italian banking crisis.
Then there is The Donald. When Mr Trump was elected president, stock markets surprised everybody by rising rather than plunging in panic. Investors chose to accentuate the positives of his proposed $1 trillion stimulus blitz and eliminate the negatives such as a potential global trade war.
However, Ms Brooks warns this may not last. “The president’s big test will come on February 28, when he addresses the US Congress. If he fails to deliver tremendous, even beautiful, plans on taxes and infrastructure spending then the bottom could easily fall out of the market.”
Fawad Razaqzada, a market analyst at Forex.com, says the era of easy monetary policy could be drawing to a close as the US Federal Reserve is turning hawkish and growth returns to Europe. “The fundamental backdrop is building up for US stocks to head for a sizeable correction – or a crash. However, the S&P 500 could still rise another 6 to 7 per cent before that.”
Mr Razaqzada says we might enjoy a final hurrah before then: “The bubble could get very large before it deflates or busts.”
James Carrick, global economist at Legal & General Investment Management, says if the Fed keeps interest rates too low for too long, it risks inflation taking off. “If it tightens too quickly, it could undermine corporate finances.”
He expects the Fed to hike rates two or three times this year, squeezing growth. “Our analysis suggests we are approaching the end of the economic cycle.”
Steen Jakobsen, chief economist and chief investment officer at Saxo Bank, says almost every traditional valuation measurement indicates that shares, bonds and property are “overbought”.
Worryingly, he thinks the Donald Trump “animal spirits” premium has made matters worse. “Any protectionist measures could wipe out the benefits of lower taxes and easier regulation.”
Mr Jakobsen says Mr Trump’s stimulus and protectionist plans will push up labour costs and import duties, and drive up inflation. “This could increase the risk of recession, which I put at 60 per cent likely in the next 18 months.”
If recession does strike, he warns that central bankers can no longer prop up the economy by cutting interest rates from today’s ultra-low levels.
He says it is possible for a number of major asset classes to crash at the same time. “Every asset has been driven upwards by extremely low monetary policy rates and this interconnection will eventually disappear.”
Mr Jakobsen says investors can protect themselves by reducing their exposure to riskier assets. “The excessive growth we have had since 2008 is likely to be replaced by a period with low to negative returns. Fixed income such as corporate bonds may offer some protection, as should commodities such as metals.”
As ever when it comes to economics, there are plenty of dissenting voices.
Gero Jung, chief economist at Swiss-based global wealth managers Mirabaud, says a simultaneous slowdown in stock markets, bonds and property is unlikely. “We believe US growth will remain firm in the next 12 months, with European growth and Japanese activity also experiencing a cyclical upturn.”
Mr Jung says investors should keep risk assets in their portfolios. “Currently we favour US equities over European. On the fixed income side, we are more cautious relative to sovereign bond exposure, as we expect inflation – including in the US – to rise gradually. We are more positive on corporate bonds.”
Tom Stevenson, investment director at Fidelity Personal Investing, says although it is theoretically possible for every asset class to crash at the same time, it would be highly unusual in practice. “Our research shows that over the last 20 years, there has not been a single year in which everything has fallen together.”
For example, after the dot.com bubble burst in 2001, US stocks fell 10 per cent and European and Japanese markets by more than 20 per cent.
However, the property market dipped only slightly, while cash and corporate bonds both rose, Mr Stevenson says. “Diversification will have smoothed the ride for investors, with cash and bonds offsetting some of the pain of equity and commodity falls.”
By contrast, 2005 was a boom year, with emerging markets up 50 per cent, Japanese equities up 40 per cent, and the US, UK and Europe up 20 per cent or more. “Corporate bonds, government bonds and cash also grew strongly, which means investors gained across the board.”
Investors can therefore protect themselves from market volatility by spreading their money across different assets, Mr Stevenson says. “Do not put all your eggs in one basket. A balanced portfolio split between equities, bonds, real estate, commodities and cash, really can help smooth investment returns and lead to better long-term outcomes for disciplined investors.”
This does not guarantee that you will come out on top year after year, but it does reduce volatility and risk. Mr Stevenson concludes: “This is really good news for a hands-off, long-term investor because it means that they can sensibly invest in a well- balanced portfolio and just forget about it.”
Sam Instone, chief executive at AES International, says instead of worrying about a crash you should heed the advice of legendary investor the billionaire Warren Buffett, who said “the only value of stock forecasters is to make fortune-tellers look good”.
The truth is that nobody knows what will happen next, no matter how convincing pundits may sound, he adds. “Investors should ignore the noise about Trump, Brexit and whether property, bonds, infrastructure, commodities or equities are going to crash, surge, peak or correct. All too often experts are trying to scare investors into using their overpriced, underperforming investment plans,” Mr Instone says.
Instead of trying to time the market or worrying about short-term shifts in share prices, he says UAE-based investors should focus on building a balanced portfolio of low-charging investments for the long term.
In this respect, investing is changing for the better. “Low-cost index trackers such as exchange traded funds [ETFs] have replaced expensive, underperforming active funds and their overpaid, fortunetelling managers to deliver much better results,” he says, recommending that UAE expats invest in index funds or ETFs every month to get “far higher investment returns and far lower charges”.
If you invest monthly, rather than paying in big lump sums, you do not have to worry about short-term corrections either, Mr Instone adds.
In fact they can work in your favour through a process known as dollar-cost averaging. This means you actually benefit if markets fall, because you buy more stock with the same monthly payment, boosting your returns when markets recover.
“Your money will steadily compound over time, without the worry of market uncertainty in between,” Mr Instone adds.
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Updated: February 24, 2017 04:00 AM