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The next 10 years in markets – this time it really is different

Mark Dampier shares what the last four decades in the markets can teach us about the future.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The four most dangerous words in investing are ‘this time is different’, according to Sir John Templeton, one of history’s greatest ever stock pickers.

What he meant was that at both stock market peaks and troughs, investors tend to ignore what the history books tell us about market cycles and assume the world has changed.

Yet this time I really do believe the world has shifted – and the way you invested your money in the past couple of decades might not be the way to invest in the next.

Below I look at what might happen, and share some investing principles for those looking to add to or rebalance their portfolio for the current environment.

But to look forward, first we need to look back.

This article isn’t personal advice. If you’re not sure whether a course of action is suitable for you, please ask us for advice.

Investing has changed

I’ve seen plenty of booms and busts in my 40-year career. Fads come and go, and different investment strategies come in and out of fashion.

Interest in investing has grown enormously since I bought my first fund. It was sparked by the wave of privatisations in the 80s, followed by the growth in unit trusts (funds), all fuelled by ever greater coverage in the media.

More people have taken an interest, as increasingly they must make their own pension provisions, instead of relying on the generous final salary schemes of the past.

It’s a period in which the baby boomers started their careers, and they’re now retiring in huge numbers. This has driven a whole economic cycle, as the boomers have bought their first homes, had children, and moved into retirement. Now we’re a generation that won’t put our slippers on, but we won’t be spending as much money as we once did, and it won’t be on the same things.

I bought my first fund in the early 80s – two Japanese funds in fact. Japan in the 80s was like the US today. Everyone flocked to it, with technology companies like Sony seemingly so far ahead of their global peers. Sound familiar?

But financial assets were valued very differently from today.

US government bonds yielded around 15% in the early 80s, and the US stock market traded on a price-to-earnings ratio of around 7. This was after a period of some 17 years when share prices in the US had stood still, but inflation globally had risen to double digits.

But something changed in the early 80s. Paul Volcker was appointed to run the US central bank, the Federal Reserve, in 1979. He bore down on inflation, which meant raising interest rates. So I started my career with shares on low valuations and government bond yields at all-time highs (which means prices at all-time lows).

Back to the future

Fast forward to today, and those US bonds yield 0.7% and the price-to-earnings ratio of the US stock market is in the mid-20s. So both shares and bonds are significantly more expensive – and in the case of bonds, the most expensive they’ve ever been.

To me these don’t seem to be great starting points for investing today. But at the same time I’m not entirely pessimistic – I just think it’s time to consider a different approach.

I think Covid-19 is the catalyst that is likely to bring these simmering problems to the fore. The US Federal Reserve and other central banks have come to the rescue, injecting a huge amount of money into the markets, which is why I have been bullish on markets of late.

I‘m still bullish, but with the caveat that it won’t last forever.

At some stage I suspect the Federal Reserve might be less willing to prop markets up. Or maybe we’ll see a wave of bankruptcies brought on by the pandemic, which could turn into a spiral.

To see how this could happen, let’s look at Hertz. The century-old car rental firm has filed for bankruptcy protection in the US, with its business all but vanishing due to Covid-19. Hertz’s primary asset is cars – something which the public have bought in their droves, mostly on credit. If Hertz has to sell its stock, second hand car prices (and probably new car prices) will fall, and we could see a deflationary spiral. If this hits more companies across different sectors, banks could even end up in trouble.

Clearly this wouldn’t be good for stock markets, and I could see them falling sharply again at some stage.

In this sort of environment investors will be looking to diversify away from shares. In my view they should look to hold some cash (spread between banks), and some government bonds (US and elsewhere). A small allocation to gold might be worth considering too.

Inflation to return… eventually?

The Federal Reserve and other central banks won’t stay idle as this happens. They’re likely to unleash whatever firepower is at their disposal – we could see negative interest rates and unprecedented levels of quantitative easing. Ultimately I believe this will create inflation.

There’s inevitably a time lag before monetary policy like this takes effect. So it might not come through until 2022/3. Moderate inflation is fine – even helpful – but if it reaches double digits it can be a real headache. Just ask anyone who was around in the 1970s.

Sustained high rates of inflation would be bad for both shares and bonds. The value of bonds is quickly eroded – they pay a fixed rate of income and a fixed capital value at redemption – both worth less and less as inflation takes hold.

Inflation is also not good news for most companies, as it also comes with rising interest rates. Gold and commodities become the asset of choice, alongside some very selective shares.

The perils of forecasting

It’s important to take all forecasts with a pinch of salt – including mine. I have tried to set out a road map, but the reality might be different. Maybe we don’t get deflation but jump straight to inflation, or maybe we just muddle through.

Just remember we are nearing the end of a 40-year bull market in bonds – from the current position it’s near impossible mathematically for them to produce the same returns as they have done.

When we say past performance isn’t a guide to the future we really mean it. I don’t think the strategies that have served investors well in the past are a sure-fire way to be successful over the next decade. It might be a bumpy ride.

For those who have accumulated wealth already, I think the focus will be to preserve it. For those who have enough time to build wealth, there could be some great opportunities to invest at attractive prices.

The cornerstones of investing

The environment might be radically different, but there are some things in investing which never change. Follow these principles and they should stand you in good stead.

Understand your attitude to risk

Risk is inherent in all assets – even cash. You need to understand what you’re comfortable with and what you’re not. Bear in mind that assets could perform differently over the next decade – just because something has done well in the past doesn’t mean it will do well in future.

More on risk

Diversification, diversification, diversification

If there’s one lesson I urge investors to learn it’s this. A wide spread of assets gives you the best chance of weathering market storms. If your portfolio is all pointing in the same direction it could deliver spectacular returns one year and be a disaster the next. Take a good look at where your money is invested. If it’s all in shares, think about adding some exposure to bonds. If your money is all in the UK, consider some global investments.

If you’re thinking of adding to, or diversifying your investments, why not take a look at some investment ideas.

And don’t ignore cash. Although it’s vulnerable to inflation, it also offers some stability while other assets are falling. It can provide some firepower to invest at lower prices if markets do take a turn for the worse.

Make more of your cash with Active Savings

Read more

Explore our Investment Times October 2020 edition for more articles like this.

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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