My years as an investor have taught me that you rarely buy enough of your good ideas, but you always buy too much of your bad ideas. This year the FT portfolio of exchange traded funds (ETFs) has been going well. The decision to buy into the UK immediately after the EU referendum worked, as did holding a lot of investments in emerging markets and other foreign currency ETFs before the vote. By August the fund was showing a return of 13 per cent since January.
As the markets rose I got more nervous. Experience has taught me that so often when the investment sun is shining and there isn’t a cloud in the sky you should buy an umbrella. The weather can change suddenly, you get wet if you have no cover, and umbrellas might be dearer when everyone wants one. Sometimes it is important to protect your gains. So in late July and during August I was taking profits and trying to cut risks.
I reduced the positions in China and Asia Property. I took some profits on the cheap UK ETFs I bought the day after the referendum. I cut euro area exposure more, as that has been a poor performer for some time and stands to lose from UK exit. The aim was to take this balanced fund down from 60 per cent in shares to under 50 per cent. Within the bond portfolio I also took some profits on the longer dated foreign currency denominated index linked bonds, and put the money into a mixture of long gilts and UK corporate bond ETFs which are usually a bit less volatile.
Sure enough, for no easily predictable reason, markets took a tumble at the beginning of September. The good news was I had cut down some of the more volatile parts of the fund. The bad news is I could have done more, and the bonds fell a bit as well. Indeed, this was an unusual share sell-off, as it started with jitters in the bond markets. So-called safe assets, good quality sovereign bonds, started the whole wobble. The fund gave up 2 per cent of the 13 per cent it had made so far this year.
So why did so many financial assets fall in price? Why did some shares fall sharply? It was an understandable worry that all prices are now artificially high because of the persistent money creation and asset buying programmes of the main central banks. Currently we have the Bank of Japan, the European Central Bank and the Bank of England busily creating money to buy government bonds and corporate bonds like they were going out of fashion. Japan is also buying up large chunks of the Japanese share market by purchasing ETFs of the Japanese index.
Quantitative easing drives bond prices to ever more absurd levels, with many Japanese and euro area government bonds offering a negative yield. Why ever would you want to buy a bond that costs you to own it? I wouldn’t dream of buying one, but many people do in the hope they will be able to sell them on for an even more silly price. It all has the whiff of Dutch tulip mania about it.
Compared to bonds, shares look better value. That doesn’t stop them falling faster when markets are gripped by worry. Here too investors gobble up anything with a reliable income in the desperate search for something that might offer some return on your money. The Bank of England is struggling with very low forecasts for the UK economy, starting from its pessimism in May that any vote for Brexit could cause a recession.
I never believed that forecast, and see positive numbers continuing for much of the UK economy this year and next. Money growth has speeded up, and retail sales, new car sales and new homes sales are all good. The Bank, believing its own forecasts, rushed into further rate cuts and more quantitative easing (QE), which has inflated the bond bubble a bit more. The Bank’s forecasts and hasty action has tended to damage confidence, but not yet sufficiently to pull down the underlying economy.
Judging markets from here is difficult. The US Federal Reserve is close to pulling the trigger of higher rates in the US, though I will be surprised to see that happen before the presidential election. If Mr Trump wins, the first reaction of markets is likely to be negative, before they turn from their collective dislike of some of his statements to considering his tax cutting economic stimulus.
Japan is still experimenting with lower rates and more bond buying, but markets are no longer much impressed by what they are doing. If I am right about the UK economy, the Bank will not cut rates again nor will it undertake more QE at the end of the latest stated programme. In the euro area they will need to widen the range of assets they can buy and relax the criteria, as they have bought €1tn already.
I am not about to sell out more, as I think we have more time with the European and Japanese authorities still trying to ease money. I remain nervous about bonds, which in turn requires some caution about shares. As economies grow a little faster, you should have a period when bonds sell off but shares thrive. It does not feel like that any more. The very forces which caused investors to behave irrationally in the quest for income could flow the other way, making them fear rising interest rates, bringing higher dividend yields and therefore lower share prices.
The problem with the authorities rigging the markets is it could be painful when they stop doing it. So I remain fully invested, with slightly less risk in the fund. I expect rates to stay lower for longer and for there to be more return, but I am increasingly nervous about all those negative yields. When people in Holland realised that a bulb was just a flower and not some superstore of value, prices crashed. When people remember the whole point of a bond is to pay you a reliable income, what will happen to the prices of negative yield bonds?
As some are now writing, QE boosts the asset prices of the rich, undermines pension funds and robs the normal saver who wants to keep some money on deposit or in a safe income bond. It’s not a great policy, but it still dictates what happens to the value of our investments. There might be one thing worse than carrying on with it, and that would be abandoning it too starkly without having something more reassuring in its place.
John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. firstname.lastname@example.org
|Cash Account [GBP]||2.0|
|db x-trackers MSCI Korea ETF||1.7|
|db x-trackers MSCI Taiwan ETF||1.8|
|db x-trackers S&P 500 UCITS ETF (DR) 2C (GBP Hedged)||3.0|
|iShares Asia Pacific Select Dividend ETF||2.2|
|iShares FTSE 100 ETF||3.7|
|iShares FTSE EPRA/NAREIT Asia Property||3.9|
|iShares FTSE EPRA/NAREIT UK Property||5.2|
|iShares GBP Corporate Bond 0-5 ETF||8.1|
|iShares Global High Yield Corp Bond GBP Hedged ETF||3.0|
|iShares Global Inflation Linked Government Bond ETF||8.7|
|iShares MSCI World Monthly Sterling Hedged||2.9|
|iShares Nasdaq 100 ETF||6.7|
|iShares Sterling Corporate Bond||3.9|
|L&G All Stocks Index-Linked Gilt Index I Acc||8.4|
|L&G Global Real Estate Dividend Index Fund (L Class Acc)||2.9|
|Lyxor FTSE Actuaries UK Gilts ETF||10.5|
|PowerShares Nasdaq 100 ETF||2.6|
|SPDR Barclays 15+ Year Gilt UCITS ETF||6.0|
|SPDR S&P UK Dividend Aristocrats ETF||2.5|
|UBS CMCI Composite UCITS ETF A-acc||2.5|
|Vanguard FTSE Japan ETF||3.8|
|WisdomTree Germany Equity UCITS ETF — GBP Hedged||1.3|
|Source: Charles Stanley Pan Asset|
Sample the FT’s top stories for a week
You select the topic, we deliver the news.