Equities

S&P 500: duration of rally in days

Source: Thomson Reuters Datastream, as at 7.9.18, total returns in local currency.

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

It doesn’t make much sense to talk about equities as a single investment class at the moment. Shares often move together but this year has seen significant divergence between different markets. Wall Street is hitting new highs while China and other emerging markets are deep in bear territory.  However, to the extent that we can take the US market as a proxy for global equities (it is after all half of the total market capitalisation), we can make some observations.

First, as of late August the current bull market is now classified as the longest ever. Its duration now exceeds that of the 1990-2000 bull run that ended with the bursting of the dot.com bubble. This rally is therefore long in the tooth and that worries some investors, although not me.
The main reason I am relaxed about the length of the bull market is that it says nothing meaningful about the likelihood of it ending. A bull market as unloved as this one can go on for a long time because it is shallow and has not yet resulted in excessively stretched valuations. Far from it. Secondly, I think you can argue that a 10-year rally is not even that long in historical terms. It is quite reasonable to make the case that the period from 1982 to 2000 was actually one long bull run, punctuated by a couple of savage corrections, in 1987 and 1990. In that context, today’s rally is not really that unusual.

One of three things will end the bull market. The first would be excessive zeal from the Federal Reserve, tightening monetary policy too fast and sending the economy into recession. This is possible, and Jay Powell does seem determined to normalise policy even if that causes some pain. But I don’t see it as a central worry.

Second, valuations could go too far, resulting in the bull market collapsing under its own weight. This also looks a long way off thanks to the earnings boost provided by Donald Trump’s tax cuts. Valuations are actually cheaper than they were at the start of the year, even in the markets that have gone up (and plenty have not).

Finally, the bull market could be killed off by some unexpected geo-political disaster. As this is by its nature unpredictable there is no point in worrying too much about it.
In summary, shares are reasonably valued, offer growth and often better income than the alternatives, are supported by economic growth and are not likely to be undermined in the foreseeable future by any of the usual bear market triggers - valuation, sentiment, inflation, interest rates. Protect yourself with diversification - and stick with it.

 

Select 50 picks: A global equity fund is the best way to get exposure to stock markets around the world. The broad canvas attracts some of the best fund managers too. We like James Thomson’s Rathbone Global Opportunities Fund and Jeremy Podger’s Fidelity Global Special Situations Fund.

 

Property

We have been describing real estate as ‘late cycle’ for a very long time now. And still it continues. Pricing in most markets can charitably be described as full. In some prime European markets, investors are willing to accept income yields as low as 2.5%. If you consider that this means a 40-year pay back, you might reasonably think twice. Would you buy a share on 40 times earnings?

Another way of looking at the property market is to compare that 2.5% yield with the estimated 2% cost of depreciation and obsolescence on a building. Property is after all a depreciating asset, something that people tend to forget in a rising market. When you also consider that an investor should be paid something to compensate them for the illiquidity of property, it is clear that many investors are taking a very long view indeed.

To make a sensible purchase in today’s environment you really need to go off piste, be very well-connected and know who to approach with a deal. The best investors are still able to find attractive deals at 5-6%, perhaps because they are willing to take a view on their ability to re-let an expiring lease, but it’s becoming much harder work.

One sector looks particularly vulnerable. If even a star performer like UK clothes retailer Next admits that it is struggling to make the ‘bricks and clicks’ model work, then we may finally have reached the tipping point where online shopping kills the high street. In this new world, retail property may come to be viewed like industrial sites used to be - requiring a higher yield and, even then, perhaps representing a value trap.

The counter argument is that investors are proving much less flighty than expected. They are not treating property investment as a tactical opportunity but a long-term commitment that can still pay a sustainable income. But the risk/reward balance is a lot less compelling.

Important information: Funds in the property sector invest in property and land. These can be difficult to sell so you may not be able to cash in the investment when you want to. There may be a delay in acting on your instructions to sell your investment. The value of property is generally a matter of a valuer’s opinion rather than fact.

Bonds

Bond yields no longer rising

Source: Thomson Reuters Datastream, 5.9.18, 10yr government bond yields.

Past performance is not a reliable indicator of future returns.

As the chart shows, yields on government bonds have risen somewhat on a one-year view (bad for bond prices, which move in the opposite direction) but they have pretty much gone sideways over six months as doubts have set in about the macro-economic and geo-political backdrop. Trade tensions are the key cloud hanging over markets and while the direction of travel for yields is probably higher, the trajectory looks like being very shallow.

Upward pressure is greatest in the US, where rising inflationary pressures, a tight labour market, rising wages and a probable pick-up in bond issuance to finance a widening budget deficit mean the Fed’s inclination will be to stick with its tightening path throughout 2019. Jay Powell, the Fed chair, wants to build up some ammunition so he can fight the next downturn when it comes. Whether he is able to do so is a moot point - the yield curve suggests he may actually be tightening faster than the market can live with (see page 3).

When it comes to corporate bonds, the gap between the yields they offer and those on safer government bonds is not particularly enticing. The reward for taking the extra default risk is not that great and that means that any slowdown in the current buoyant earnings growth picture could lead to a widening in spreads (and therefore to lower corporate bond prices). The absence of a risk premium is even more pronounced among lower quality companies.

Emerging markets offer much higher yields, but there is a good reason for this. In an environment of rising US interest rates and a stronger dollar, the returns on offer may represent something of a value trap. A lessening in trade tensions, moves to support the Chinese economy and evidence of a more dovish Fed would help.

Select 50 picks: Bonds have a place in any well-diversified portfolio and a strategic bond fund that can move up and down the risk spectrum is the right way for most non-specialist investors to get their fixed income exposure. There are two strategic bond funds on the Select 50 list. Both are run by experienced managers who have seen plenty of cycles before. The Fidelity Strategic Bond Fund and the Jupiter Strategic Bond Fund will both provide balance to the equities in a diversified portfolio.

Important information: There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall..

Commodities

Diverging commodity prices

Source: Thomson Reuters Datastream, 7.9.18, total returns in local currency, rebased to 100.

Past performance is not a reliable indicator of future returns.

Commodity prices have diverged this year as the chart shows. The oil price, which is far and away the most important global commodity, and so dominates the baskets of resources tracked by the main ETFs, has had a third good year on the trot. Industrial metals, on the other hand, have suffered from a slowing in global activity, notably in China.

With a lack of correlation within the asset class and with other assets too, commodities are a good way of diversifying a portfolio. Like equities, they tend to benefit from an increase in growth but they tend to do so at a slightly different point of the cycle so they can help to smooth out the ups and downs of a portfolio with a high equity content.

When the economy moves into the late cycle, as it is now, risky assets like shares can move in the opposite direction to oil especially as a higher crude price acts as a speed limit for growth, eats into company profit margins and depresses consumer spending. A rising oil price also puts upward pressure on bond yields as inflationary pressures increase, which makes bonds a less good diversifier versus equities at this point.

For these reasons, some exposure to commodities, especially oil can be very welcome in the later stages of the cycle. This can be achieved in a number of ways. One is to look into the top ten holdings of global, UK, US and European equity funds on the Select 50 for those with a higher weighting towards oil stocks. The Invesco Perpertual Global Equity Income Fund is a good example. Alternatively, there is a number of commodity-focused ETFs on our investment platform at fidelity.co.uk.

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