What to buy as investors turn fearful again

published 5 May 2011

The markets are rattled.

US economic data was disappointing yesterday. Readings on both job creation and service sector activity were weaker than expected. With Portugal's bail-out also hitting the headlines again, perhaps it's understandable that investors were jittery.

But the malaise goes deeper than this. Commodity prices seem to be rolling over. And stocks were already slipping this week.

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So what's really worrying investors?

US economic data has been disappointing

US economic data disappointed investors yesterday. A key survey from ADP Employer Services showed that private sector job numbers grew less than expected last month. That has left investors nervy ahead of the all-important official non-farm payrolls data, out tomorrow.

And the latest data on the services sector was terrible. The Institute for Supply Management index for April fell to 52.8 from 57.3. (A reading above 50 indicates growth). That's quite a slump. And the reading for new orders plunged from 64.1 to 52.7. As Steven Ricchiuto of Mizuho Securities US told the FT: "It appears that purchasing managers may have suddenly woken up to the reality that no one is getting hired who can buy all the goods that their firms can produce".

The weak data helped send US stocks lower for the day. But there are signs that investors had already been shifting into 'risk off' mode.

Silver, copper, oil and bonds all suggest risk appetite is waning

The slide in the silver price (you can read what my colleague Dominic Frisby has to say about that here: Silver could fall as far as $22 but the bull market isn't over) is just the most obvious sign that risk appetite is shrinking. When the gold/silver ratio hits extreme lows as has been the case recently it's a sign that investors are getting over-excited. So the drop in silver perhaps shouldn't come as a huge surprise. (You can read more about the gold/silver ratio here.)

Copper often seen as a useful forward indicator has also fallen, hitting a seven-week low yesterday. Meanwhile, the price of crude is easing too, as the realities of supply and demand start to catch up with the market. Petrol demand in the US is down by 1.9% year-on-year, even although the economy is meant to be getting stronger.

You can spin out any number of explanations for all this. But the most obvious is that investors are finally starting to worry about what will happen when quantitative easing (QE) ends. After Ben Bernanke's press conference at the end of last month, the market remained happy because he had no plans to raise interest rates.

But that still leaves the question of what will happen when the Fed stops pumping printed money into the economy. Paul Kasriel of the Northern Trust, who has a good track record, argues that QE has been the main thing keeping the US economy afloat. QE has allowed commercial banks (high street banks) to do the little lending they have been doing. The concern is that if QE ends, and the banks fail to pick up the slack themselves, the US economy will stall again.

The trouble is, the banks aren't in any mood to lend. US house prices are falling again, which leaves banks vulnerable to further bad debt write-offs, not to mention the legal concerns still hanging over their repossession processes.

What will happen as QE ends?

What's likely to happen? MoneyWeek regular James Ferguson spelled out his worries over the end of QE a couple of weeks ago in MoneyWeek magazine subscribers can read the whole piece here: What happens when quantitative easing ends? But in short, if QE3 isn't announced, then 'risk' trades like commodities and cyclical stocks will suffer, while you'll want to be in the likes of blue-chip stocks, cash and reckons James government bonds.

On this last suggestion, my own view is that while bonds may well rise in price, I'm not keen on buying them. Right now, buying US government debt is pure speculation. You're betting on the Fed's next move. If you want to trade them, that's fine. But if you're looking to invest your money for the longer run, I'd far rather buy a part of a company that will hopefully over the years deliver both a decent income and an element of growth.

On that note, my colleague and Asia specialist Cris Sholto Heaton has written about Asian income stocks for the latest issue of MoneyWeek magazine out tomorrow. It could be a useful way to diversify your income portfolio if you've already got exposure to the sorts of developed world, high-quality blue-chips that we've been recommending for some time now. If you're not already a subscriber, subscribe to MoneyWeek magazine.

As for more speculative moves: if you want to trade the correction in commodities, then I'd look at the Aussie dollar, rather than US Treasuries. Australia is effectively a play on the commodities boom and the Chinese economy. If China looks like slowing down, and commodity prices come off, the Aussie dollar will suffer. Indeed, it's already dropped quite sharply in the last three days against the US dollar. On top of that, Australian house prices have been slipping back too, which may mean interest rates don't have much further to rise there.

Obviously, spread-betting on currencies (arguably the easiest way to play the market) is a risky business and you can easily lose more than your initial stake if you're not careful. So sign up to our free MoneyWeek Trader email, where John C Burford spells out his tips and strategies for finding decent entry and exit points for trades, and for managing your money so that one bad trade doesn't wipe you out.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.