Normal assumptions about investing in share and bond markets have been turned upside down by Europe’s debt crisis, according to John Chatfeild-Roberts (pictured), Chief Investment Officer and Head of the Jupiter Merlin Independent Funds Team at Jupiter Asset Management…
Making investment decisions has become trickier than ever with the gloomy outlook for the world economy on the one hand, but on the other, attractive valuations of many assets. Markets have swung like a pendulum as investors respond to these opposing pressures.
The start of a New Year changes nothing. 2012 will be a year when investors need what Tolstoy called “the two most powerful warriors”: patience and time - in order to get the most out of their investments. Europe’s crisis rumbles on and predicting the final outcome is very difficult but further financial blood-letting will be required before the global economy can heal. European politicians have treated this as a crisis of liquidity – a temporary shortage of cash – rather than one of solvency, where countries’ finances are unsustainable. As a consequence, the woes of the single currency zone could take a heavy toll on world growth. If there is a recession on the Continent, the UK will not be immune from the knock-on effects.
This crisis has created a dilemma for investors struggling to assess risk. Received opinion places cash and government bonds at the lower end of the risk spectrum and shares at the higher end. Now the concept has been turned on its head. In a world in which sovereign debt and the banking system are under such strain, cash and government bonds may not offer the comfort investors usually expect. Even supposed “safe havens” may not be as “safe” or as low risk as they appear.
Bonds issued by the UK and the US governments, for example, are currently in heavy demand as investors see them as a “safe haven” from Europe’s woes. But if you analysed them in the same way as you would equities, you might think differently. UK gilts, for example, currently pay a yield of under 2%. This gives you no protection against inflation of 4.8%, provides no dividend growth and is backed by a country with very high debts and weak long-term growth prospects. Yet such is the demand that it is priced at highs not seen for over 100 years. One cannot put the US, although burdened by high debts, quite in the same category as the UK because the dollar is still the world’s reserve currency. But still, a yield of around 1.9% on 10-year US Treasuries suggests this is not a cheap investment.
However, there are plenty of opportunities for investors prepared to take a long term view. The shares of healthy multi-national companies with strong balance sheets that can maintain good dividends look far more attractive. Share prices may be more volatile in the short term but I would feel more confident owning a portfolio of high quality income stocks such as Glaxo and Shell, which have attractive valuations and healthy dividend yields of around 4.7% and 4.4%, than I would holding the bonds of most supposedly triple A-rated countries. Or, for that matter, the deposit accounts of most European banks. Such dividends are decent compensation for any short term ups and downs in price.
Emerging markets were not a profitable place to invest in 2011 but prospects for some of these markets look brighter. China’s property market is looking sick but when the rapidly-growing middle classes in these countries start spending on a western scale, we might witness a genuine de-coupling of the two speed global economy. Investors need an eye to the long-term to profit from this.
With a US recovery looking more likely, its housing market, which has fallen over 30%, appears to be bottoming out and given continued population growth, buying a house in the US now may prove a good investment decision long term.
Even Europe will eventually recover; and markets will move to discount this well in advance of the problems actually being resolved. Big crises have a habit of creating big investment opportunities - Europe is having an especially big crisis - therefore over time, we can expect to see some wonderful opportunities unfolding. At this stage though, the Jupiter Merlin team remains defensively positioned. The point will come when the scales start to tilt back to favour increasing risk levels but we are not there yet.