Sheep In Wolf’s Clothing

16/05/2014 at 3:53 pm

As this week showed, markets remain jittery. The FTSE 100 had edged up to a new high of 6878 on Wednesday, only a handful points short of its all-time closing peak of 6930 in 1999, only to give up its gains yesterday in the biggest daily fall for a month. At the same time, the ten year gilt yield – which had been stuck in a range of between 2.6% and 2.8% for three months – broke lower in the biggest one day fall since January to reach its lowest point since last July. And continued euro weakness saw the pound reach a new high of 0.814 (or 1.23 for those of us who prefer our sterling exchange rates the right way round), its strongest level against the euro since January 2013.

In fact, listen to some fund managers and 2014 has been a shocker. Technology shares, which were supposed to keep going up, have underperformed, with the NASDAQ down in absolute terms and 4% behind the S&P 500 for the year to date. Indeed, some of the big internet names in particular have taken a major bath: Amazon is down 26% and LinkedIn down 33%. Last year’s massive bull trend in Japan is nowhere to be seen with the Nikkei 225 down 13%, comfortably the worst performer of any major market. Emerging markets have been outperforming (by 5% over the last three months). Duncan’s horses have turned wild in nature and gone for a picnic. For many participants it has been a bruising time.

And yet in truth, things have not been as exciting as it has sometimes felt. Equity market volatility has not been anything like as high as it was when the taper tantrum kicked off just under a year ago. Indeed, some swift linear regression to the FTSE 100 over the last 12 months shows that its line of best fit has risen 4.5% in price terms over the period. Coupled with a dividend yield of about 4% and CPI inflation of an average 2.3% over the same period and you’re looking at a real return of 6.2%, which is so near to the textbook number for expected long run returns to equity as makes no difference. Putting it another way: the equity market, despite patches of volatility and some sector fireworks, has in aggregate been quite boring – and that was always the consensus view for the major markets going in to 2014.

The economic data has been unspectacular too. Eurozone GDP for Q1 out yesterday was a little weaker than expected, but there was nothing to derail the expectation of dull and sluggish – but positive – growth this year. Employment data has continued to show measured strengthening at home and in the US, while in both countries, activity indicators have stayed healthy though below recent peaks. There have been no signs of further deterioration in EM, nor any evidence of anything beyond a gradual uptick where numbers have been positive. On the political front the Ukrainian situation remains worrying, but there has not yet been anything to match the annexation of the Crimea and there have been no more big surprises elsewhere.

In fact wherever you look – eurozone bond markets, precious metals, credit spreads, oil and gas – there have been occasional episodes of excitement, but nowhere near enough to keep the casual viewer watching. It has been a dull old time. (Unsurprisingly this will have benefited dull old portfolios. Income investors, both within equity markets and as holders of bonds, will have done pretty well.)

So these jittery markets have not really been as dangerous as they seem. But since nothing lasts forever, the question is: how worried should we be about what comes after the boredom? Will “risk on” be unharnessed as recovery continues? Or will there be another shock, or disappointment, which will make the last few months seem like the calm before the storm?

Perhaps the most sensible approach for investors to take in these circumstances is to resist the temptation to actually do very much. There has been little change in fundamental data to challenge whatever positions they may be taking, and in many markets, rarely enough volatility to suit those waiting either for a buying opportunity or to take profits. Best to stick to one’s views, save some trading costs, and see what happens next …


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