Caution but not capitulationAn experienced financial journalist put three very sensible questions to me last week: “Why should I own a global equities fund right now? Shouldn’t I just avoid the stock market all together? Isn’t that why you have nearly 20% cash in your fund? ” I have been hearing such questions with increasing frequency on recent marketing trips. It is certainly a time for investors to exercise caution. But it is too heroic to avoid risk assets altogether in the hope of investing everything at the bottom. The best approach to investing takes a medium to long-term horizon, and the first priority should be to maintain the purchasing power of both capital and income. At a time when inflation is picking up, the protection offered by ownership of a carefully-selected list of high quality companies with pricing power is not to be underestimated. It is preferable, in our view, than having an investment portfolio dominated by bonds, after a long period of spread compression as investors have chased yield in a low rate world.
Overvaluation and overleverageThese are undeniably challenging times to invest inequities. Developed stock markets are close to multiyearhighs, led by a euphoric US stock market, which bysome measures is now in the longest ever bull market inhistory. Valuations are stretched, and what is even moreproblematic is that this is true across the board, unlikesay 1999 when it was concentrated in particular sectors.There is no equivalent of the ‘old economy’ stocks whichwere genuinely cheap (and defensive) in 1999.And this is despite there being plenty of reasons to beconcerned. The US economy is in distinctly late cycleterritory, with the Federal Reserve in interest rate-raisingmode while at the same time engaging in quantitativetightening. We have mounting global trade tensionsstoked by a highly unpredictable US president, winnertakes-all technology platforms destroying establishedbusiness models and disrupting industries, economicand political volatility across emerging markets, and theongoing sweep of political populism in the West. Couldany one of these issues explode and be the catalyst tocrack developed markets?Perhaps, but the underlying cause of capital destructionwill be the same as it always is: a lack of disciplinein financial markets during the good times leading tooverleveraged companies and overvalued financialassets. The right question is not “when exactly willthis lead to a market downturn?” – it is rather “whatinsurance can I take out now to protect me from theconsequences when (not if) one happens?