Investment waters are distinctly choppy at the moment. The first few months of this year were characterised by a wave of optimism based on the fact that the global economy was recovering slowly (which was good for stock markets) but not recovering strongly enough to stop central banks around the world from printing money (which was even better for stock markets).
As ever, when something looks too good to be true it generally is and Ben Benanke, chairman of the US Federal Reserve Board, in his testimony to Congress at the end of May broke the spell by confirming that, while quantitative easing (QE) would continue, it would not go on forever. Later speeches set out a timetable for withdrawal of monetary stimulus altogether as the economy revived.
Markets are now having to wean themselves off the short-term “sugar rush” of QE and on to the long-term nutrition of economic growth.
They know which is good for them. But they know which they prefer.
To muddy the waters further, there are worries a credit bubble is building in China, which is unsustainable as their economy slows, and there are unresolved problems in Europe which could yet threaten the single currency.
So, as summer progresses, markets may well continue to be volatile. Trading volumes are traditionally lower in summer as people go on holiday and senior dealers are away from their desks. In this “thin” market prices are easily moved by economic data, company announcements and world events. But this throws up opportunities. Furthermore, with government gilts and good quality corporate bonds trading at record highs and likely to fall when interest rates eventually begin to rise, longterm investors are increasingly looking to the equity market to offer a sustainable income stream and protect the purchasing power or the “real” value of their investment against any pick-up in inflation.
The average “yield” or income return on the stocks that comprise the FTSE 100 Index is 3.7%. With the judicious extraction of those companies that do not pay a dividend or have a relatively low yield it is perfectly possible to construct a diversified portfolio of shares which will generate an income of about 4%. This income stream should increase in line with inflation and, as the dividend income improves, so too should the invested capital appreciate.
Obviously there are risks associated with stock market investment. The small print will always tell you equities and the income derived from them can fall as well as rise.
However, equity market valuations do not look stretched and, for those prepared to invest for the long term, current markets, while looking a little storm tossed, could yet be bountiful.
:: Barney Hawkins, divisional director, Brewin Dolphin