Asset allocation is at least as important as individual share selection. So where should you be putting your money? Here’s our monthly take on the major asset classes.
The dash for anything
“It’s not just a ‘dash for trash’ – it’s a dash for anything.” That’s how Michael Collins, a credit strategist for Prudential Fixed Income, describes the frenzy for yield that has prompted investors to rush in to risky corporate debt, or junk bonds, in recent years. As prices have soared, junk yields have fallen to mid-single digit levels – levels that in the pre-crisis era would be more typical of (far safer) government debt. That shows how expensive most corporate debt has become, which is the main reason we don’t like it.
Government bonds also look too pricey. The threat of interest rate hikes looms in the longer term as the economic recovery continues. Rising rates (or rising inflation, if rates aren’t hiked quickly enough) are bad news for the price of all kinds of fixed-income assets, as yields have to rise, and so prices fall, to attract buyers.
Insurance against inflation
The near-term outlook for gold and silver is uncertain, as monetary policy threatens slowly to return to normal. Longer term we still like gold as an insurance policy (for 5%-10% of your portfolio) against financial upheaval – there could well be economic and market turbulence if the Ukraine crisis worsens, the eurozone erupts again, or higher interest rates hit growth badly in the debt-soaked global economy.
There’s also the threat of inflation – the velocity of money, as well as quantity, is key here. The unprecedented quantities of cash already printed could see a surge in prices as the credit squeeze of recent years eases, allowing money to move around the economy faster. Gold, the ultimate store of value, would be highly sought after.
Britain’s overpriced housing market continues to gather strength, with prices up by around 10% in the past year, according to Nationwide. London, with prices up by nearly a fifth in a year, is going from absurdly overpriced to insanely overpriced. Propped up by foreign money, the average house ismore than twice as expensive as its national counterpart. However, London may be showing some signs of wilting. In terms of investment potential, we’d rather focus on smaller German cities for now.
Oil supply is rising
Crude oil prices could ease from the current level of around $110 a barrel. Libyan and Iranian output looks set to rise, while US production remains healthy – it has doubled in eight years. Demand is unlikely to surge as China’s government clamps down on credit and Europe recovers slowly. On natural gas, we remain bullish long-term. As Capital Economics points out, legislation in both the developed and the emerging world will encourage a shift to gas from oil and coal because it is the ‘cleanest’ fossil fuel.
Problems are priced in
The prices of many raw materials have steadied in recent weeks. Markets appear to have decided that fears of a sharp slowdown in China, which accounts for around 40% of demand for many metals and 30% of global soy consumption, were a tad overdone, reckons Sameer Samana of Wells Fargo Advisors. If so, don’t expect a quick recovery.
The Chinese government appears determined to clamp down on lending. Increased production, planned years ago when China began to boom, is finally coming on stream, as The Wall Street Journal’s Wayne Arnold points out. However, mining stocks have largely priced in the subdued outlook and remain worth exploring.
Agricultural commodities will fall back from recent weather-induced spikes, but look good over the long term as populations expand and arable land becomes scarcer. But play this story with fertiliser and farm equipment stocks, not the highly volatile softs themselves.
Developed markets at record highs
Major developed markets have stayed near multi-year or record highs, despite tension in Ukraine and a disappointing US earnings season. While the upswing that began in 2009 is looking long in the tooth and the US market is “priced for perfection”, as MoneyWeek’s Tim Price puts it, there are still opportunities in Europe and especially in Japan, where half of the market is priced below book value and ‘Abenomics’ continues to bode well for equities.
Over the past few weeks, investors spooked by last year’s emerging market turmoil have started to return. We are cautiously optimistic too. The outlook has clouded over as commodities have fallen out of favour and central banks have raised interest rates to stem currency slides. But the slowdown should now be in the price, and emerging markets still offer faster growth and lower overall debt than the rich world. Frontier markets, on the other hand, are starting to look a bit overcooked.