Equity markets may be flying high but place your bets carefully…

12th June 2014


Patrick Connolly certified financial planner and head of communications at wealth manager Chase de Vere looks at the lay of the land given the exuberance of equity markets…

Good news, good news, good news. Roll up and buy now…

The UK economy is recovering well and beating growth expectations. We’re seeing increasing levels of merger and acquisition activity and the unemployment rate is down to just 6.6%. This is below the 7% rate suggested by Bank of England governor Mark Carney last August as the threshold at which there could be interest rate rises. At that time the unemployment rate stood at 7.8% and Carney predicted it could take three years to fall below 7%. This is an indication of how far we’ve come and how quickly.

We’re seeing improving confidence amongst UK consumers and employers and you won’t need telling how buoyant the UK property market has been, particularly in and around London.

The good news isn’t confined to the UK.

It is the US economy which is leading the global recovery as it benefits from an improving employment picture, a recovering housing market, banks behaving and lending normally, a renaissance in manufacturing and consumers feeling more confident.

Patrick Connolly, Chase de Vere

Patrick Connolly, Chase de Vere

The excavation of shale gas and oil is helping the US move rapidly to a state of energy independence. This gives the prospect of energy supplies being produced for many decades, pushing down costs for both businesses and individuals.

Against this backdrop we’ve seen unprecedented levels of support from central banks, including pumping huge amounts of money into economies through quantitative easing (QE) and holding interest rates at historically low levels. While QE is being slowly scaled back in the US, it is likely their authorities will remain accommodative and act further if necessary.

While the US is scaling back, we could see further action from the European Central Bank (ECB) to counter the possible threat of stagnation or even a fall into deflation. The ECB has been cutting interest rates and could even adopt a US-style QE program.

It is no wonder that in an environment where economies are recovering, sentiment has improved and central banks are so supportive that equity investors have done well. A number of markets are at or around record levels including those in the UK and US. With such good news abounding surely now is a good time to invest.

The latest statistics from the Investment Management Association (IMA) suggest that’s just what people are doing, with equities being the best selling asset class every month since March 2013.

Unfortunately investors have an uncanny knack of jumping in at the wrong time. The result is that too many people buy at the top of the market but ignore equities, or even worse sell out, at the bottom. They wrongly see raging stock markets as an invitation to buy rather than a warning sign that gains have already been made.

And so to now……..

We seen vast sums of money pumped into economies which have supported stock prices and markets rise as equities in general have been re-rated. Valuations of many stocks now look stretched and so we need to see improving earnings to justify these valuations. There is no guarantee this will happen.

Other risks also seem to be largely forgotten. Is Europe completely out of the woods? Are we confident about emerging markets growth? Could the situation in Ukraine deteriorate? Perhaps most importantly, what happens as QE is withdrawn and interest rates start to rise? Surely central bank support cannot continue forever.

Markets won’t keep ignoring the risks and when sentiment turns it could happen pretty quickly. We just don’t know when. In the words of renowned economist JK Galbraith, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”

What we do know is that March 2009 was a very good time to invest and those jumping in now have missed out on gains of around 100% since that time. That doesn’t mean that markets can’t go higher from here, but it does mean there is more risk they will fall.

Investors can adopt a tactical approach trying to time markets by selling out at the top and then buying again at cheaper prices, though very few manage to do this successfully.

It’s usually better off adopt a longer-term approach, sticking with shares through thick and thin and rebalancing regularly by taking profits from those areas which have performed well and reinvesting in those that haven’t. You can reduce risks by investing in other asset classes such as fixed interest and property alongside equities and, if investing new money, you can do this on a monthly basis to negate the risk of market timing.

Equities can still offer good prospects in the long term, though you might be thankful if you also take steps to manage potential downside risks.

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