Equities

It seems that the World’s financial markets are entirely dependent on the US and, in particular, the Federal Reserve Bank to provide any stability in times of turmoil.  On Monday stock markets around the world suffered large losses, some more than 5% as worries about the possibility of a recession in the US came to a head.  Panic fed panic amongst investors throughout the day leaving the wider public to digest lurid headlines about financial meltdown.  Monday, as luck would have it, was a public holiday in the US so no trading took place but forward contracts indicated a fall in excess of 5% was likely on Tuesday with the probability that this would trigger further falls elsewhere.

It is possible to argue for creative destruction but market turmoil does no one much good in the long run and can impact on the wider economy, meaning real people can lose their livelihood.  Globalisation may mean that the poorest people in the developing world may suffer the most.  This means positive action to avert the worst of a crisis is to be welcomed and the world was found wanting, consigned to being mere bystanders. 

The Fed, however, sees things differently and cut rates aggressively before markets opened in New York on Tuesday.  This did not prevent stocks falling but it did cushion them somewhat.  London then led the Far East in mounting a recovery of sorts.  It is clear that the current instability has some way to go yet but it may be possible to mitigate against the worst of its effects.

Of course, it is possible to lay much of the blame for these problems at the feet of the Fed but it is reassuring to see that they are not simply standing back and observing events as they unfold.

Many investors in shares are wondering how they should respond to the current volatility in most Stock Markets and the fear that 2008 will be as troublesome as last year, if not more so.  The answer to this really depends on why you are investing and for how long.  Many cash rich emerging nations, such as Kuwait, China and Singapore, and other wealthy investors are greedily gobbling up almost anything we are selling at a knockdown price.  They have very long time horizons and very deep pockets.  For them, the prospect of picking up stakes in some of the developed world’s finest financial institutions at five year lows is too good to miss.

I strongly suspect that many guardians of public wealth in the UK, for example, company pension funds, are eager sellers and may well have proved once again to have sold at exactly the wrong time whilst buying into, probably, bonds at the wrong time as well.  Like second rate defenders in football, they seem destined to rush time after time towards the player with the ball only to see it deftly passed to another who has space and time.  Oh, the humiliation of it all.  Meanwhile, much as the England Football team are often found to wanting custodians of the hopes of a nation, the trustees responsible for around £1 Trillion of the public’s money are wrong footed by foreign operators to whom they gave the game in the first place.

Where does this leave the rest of us?  Well, if you are investing in shares you really ought to know that they will not deliver stellar returns year after year and sometimes suffer losses from which they can take quite a while to recover.  It makes sense to diversify your investments away from shares alone, this is generally held to be a sensible strategy but you should ask yourself about how long you intend to be invested.  If, like Kuwait, you expect to be an investor indefinitely, then, perhaps, you should not worry about how poorly things are going now but wonder whether you are in a position to buy something on the cheap.  It is odd how discounts in shops turn us into buyers and discounts in stock markets turns us into sellers.

Now may be a good time to reflect on whether you have the stomach for stocks at all, there is no shame in admitting that they hold too much fear.  Fear and greed need to be kept in balance and shares can be more scary than, for example, fixed interest investments.  What is wrong with holding index linked bonds?  They may not offer the prospect of much real growth but you may be able to sleep at night.

If you are the type of investor who habitually chases last year’s performance, you will, no doubt, be about to commit a significant proportion of your portfolio to Emerging Markets.  The MSCI Emerging Markets Index was up 35% last year (so long as you measure your wealth in dollars, that is) and has quadrupled investors’ money over the last five years.  With Commercial Property out of favour and Equities in Developed Markets seemingly dogged by uncertainty (is there ever much certainty about the future?), history would suggest that money will be heaped upon those sectors which can show a strong recent showing.  The question for rational investors is whether this makes sense.

There are two ways of trying to answer this, although both are unlikely to be truly accurate.  Firstly, we can fall back on analysis of the fundamentals, e.g., comparison to historic valuations or economic outlook, knowing of course that life is rarely that simple.  Secondly, we can apply the coin flippers technique and wonder whether we can throw heads yet again.  This is not the place to broaden the discussion into statistics but it would be wise to consider how likely the Emerging Markets sector is to do so well over the next five years.

Most of us, however, will simply place our belief in diversification, happy with the comfort it brings and secure in the knowledge that we do not have all our eggs in one basket.  If you have a hunch about the coming year, it might not hurt to punt a very small amount on it, if only for interest.

Driving to Perth Zoo this morning, we were listening to MIX 94.5 FM Radio Station, which is pretty much as you would expect and much the same as many pop stations in the UK.  Whilst the music is patchy, the station clearly expects its listeners to take an interest in matters financial.  At the end of a news bulletin came a piece of the current state of the Australian stock market and the benefits of overseas diversification.  It is hard to imagine a similar station doing the same in the UK, I would expect the audience to be almost universally uninterested.

Now, this hardly constitutes exhaustive research allowing us to conclude that Australians are more sophisticated than their British counterparts when it comes to investing but it does form part of a consistent picture, as I have commentated before.  Australia is very different to the UK in many ways, not all of which are better, but they run a budget surplus and seem to take pension funding very seriously as a nation.

 Of course, it helps to be sitting on top of a disproportionately high amount of the world’s natural resources but they do seem determined to make the most of their good fortune.

There is some evidence (courtesy of the IMF) that the economy in Sub-Saharan Africa is growing faster than the world as a whole.  Not by much but when you consider the considerable effort some of its governments put into preventing any growth, this has to be seen as good news.  It still lags behind the Developing World, taken together, but a case is starting to emerge for including the continent in a portfolio.  I expect that this resurgence is a little fragile; were China, for example, to lose its need for African raw materials, things could take a turn for the worse.

Also, despite the enthusiasm of some fund management companies, it is not an easy place to invest and the local stock markets will not have much capacity for major inflows of capital.  In investment terms, Sub-Saharan Africa tends to mean South Africa plus stocks in companies involved in mining, for instance.  The political risks are considerable in much of the continent and it is probably a long way off being seen as a new China were, for all its faults, the government is seen as stable and not wholly irrational.

For those holding cash, now could be a fantastic time to pick up some stock market investments at a knock down price, while some commodities (previously, the darling of investors)look overpriced.  Of course, it is perfectly possible that markets could drop further, after all, even if markets are efficient, they are not always rational.  At the moment, however, the stock markets, in particular, are volatile because investors are finding it hard to gauge the full extent of the sub-prime problem and its longer term impact on corporate profitability.

For those looking to hold investments for the long term, the FTSE100 looks a bit of a bargain at around 6300 when it has traded above 6700 only a matter of months ago.  The cautious, though, will be mindful of the fact that the index has yet to regain the heights of 1999 when it exceeded 6900.  It is always possible that we are in the early stages of a protracted bear market but many will find it hard to believe that the banks, even with all their problems, are as bad a profit prospect as their price would suggest.  Now, more than usual, we are seeing the benefits of diversifying.

For some investors, the January Sales have come early in the Stock Markets.

During the current market volatility, by which, we mean that the stock market valuations are up and down like a yo-yo, nervous investors tend to worry about their prospects for returns.  Also, there is an inclination to obsess about capital growth.

For those with an eye on history and a longer term outlook, however, the real action is in dividend payments.  In this year's Barclays Equity Gilt Study, it shows that £100 invested in 1899 would be worth £213 in real terms on the basis of capital growth.  Reinvest those dividends and the value today would be £25,022, which is quite respectable.

Now, 108 years is longer than most people would expect to be invested but, with longevity increasing by the week, a sixty year old should be planning on the basis that they may be around for another thirty-five years or so.  Even then, they still would not receive one of the many telegrams the Queen sends out every year.

Of course, when markets seem to be dangerous places, it is hard to think long term but, for those who do, there would seem to be every chance of being well rewarded.

I know it makes me sound like an old duffer but I am sure fashions come and go quicker these days.

The latest must have investment accessory is the Inverted Index Fund.  These return the opposite of the index and allow investors a way of shorting.  There are not many ways for private investors to take advantage of a belief than an index (or other investment) will go down in value, other than not investing in it, so some will welcome there arrival.  A number of fund groups are scheduling launches, almost certainly in equities and commodities so watch this space.

Whether there is a place for these in the portfolio of a long term investor, I am not so sure, but they are certainly of interest.  Technically, many things are becoming possible and I am sure we have only just seen the start of much innovation but as investors we shall need to be careful not to be sucked into the hype.

If, however, you have been waiting for a simple tool to allow you to make money (we hope) from shorting, it may be that your waiting days will end soon.