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Adrian Taylor looks at volatility in the investments
arena.
We all like the idea of having 20/20 vision to allow us to look
to the medium and long-term to invest with confidence. However,
when even the short-term horizon is difficult to define, we can
experience periods of increased volatility – making
charity trustees understandably more nervous.
Throughout 2010 we have argued that investors will soon reach an
economic crossroads, but it was hoped that, by that time, the best
direction to take would be adequately signposted. The following
factors suggest we face a choice of two roads.
The high road
Investors have grown confident that the co-ordinated global
quantitative easing programme, brought in as a result of the
financial crisis, has succeeded. We may have entered a mild
recession in the later part of 2009, but a repeat of the 1930s
style depression has been avoided.
The new Coalition Government's Emergency Budget was well
received, as it sought to calm global investors by reassuring them
that austere deficit reduction measures were balanced and
manageable and would lead us into a healthier and more productive
future.
The likelihood of a double dip recession has diminished, and
although the UK economy is not expected to sparkle in 2011,
investors have become more confident and risk tolerance has
increased marginally. This has led to a rally in the bond markets,
and more recently in equities, as company profits have met
expectations and analysts have upgraded growth targets for
2011.
This has led to an improvement in the dividend outlook. At the
same time, income yields on much of the UK FTSE Index are at
historically high levels and exceed those available for government
bonds.
If the economic recovery can be sustained, company
profitability will rise, suggesting higher capital values. Capital
growth and attractive income seems an easy option.
Inflation may not be a major threat at the moment but if all
these factors are played out then these pressures will rise in the
future and the current low interest rate policy may have to be
tightened sooner than many expected.
The low road
Recent data suggests the economic recovery is anaemic and may
not provide sufficient momentum to become self fulfilling in 2011.
While this potential problem could be alleviated with further
government stimulus (the so called QE2) there is concern that the
authorities are running out of ammunition.
The Government's upcoming autumn Spending Review was always
going to be carefully monitored, but cracks may already be
appearing with resistance to spending cuts mounting and forecasts
of tax receipts lowering as economic growth expectations are
trimmed.
Given that the impact of the initial public sector cuts have
yet to be felt, many observers believe that the outlook for the
consumer sector is still too optimistic and that unemployment is
set to rise, affecting both the discretionary spending market and
the property sector. The Government is hoping that cuts in the
public sector will be cushioned by new investment in the private
sector. There is no real evidence that this is being seen and there
is talk of imposing greater public sector cutbacks in coming
months.
If the evidence from the USA is a guide, then we need to be
concerned. In the first few months of 2010 the US economy emerged
strongly from the 2009 recession offering hope of sufficient
momentum to allow the authorities to ease back on its fiscal
stimulation. Recent data however all but confirms that the recovery
has fizzled out and suggests the threat of a double dip recession
is a real possibility.
Where to from here?
We are now at the crossroads, but regrettably the signposts are
not that helpful. Trustees should be aware of the risks associated
with biasing their investments strongly one way or the other.
Volatility has increased during the year which reflects investors
switching between the two sets of factors described above. In the
very near term we see this continuing to be a feature of investment
markets.
There is no merit in taking a big gamble in a game where the
factors determining the outcome are so unclear. There are many good
economists and strategists whose opinions we value strongly, but
when their views are polarised into two opposing but well argued
camps this sends a strong message. It may be better to take the
prudent approach and look to reduce the increasing pressure of
volatility (risk) rather than chasing gains. Perhaps we should
consider travelling in two cars and try to pick the best options
from both routes away from the crossroads
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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