My five-point investment plan for an unpredictable world

Investment is described as a triumph of optimism. Over the long run, that is true. Shares have outperformed cash by a huge cumulative margin over extended periods of time. If you do not need to access your money in the short run, it would be foolish not to have a significant exposure to the stock market.

Over shorter periods, the odds are not stacked so much in your favour. The price we pay for the long run outperformance of shares is their short run volatility. Markets rise over time but along the way they swing around.

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Timing those gyrations is difficult, but if you are looking for a guide to where markets are heading, you could do worse than studying the ups and downs of investor sentiment. When markets rise, investors are optimistic; when they fall, pessimism kicks in. It is as close to a rule as you get in this game.

Sentiment can be a useful contrarian indicator, even if its signals are easier to describe than to follow. Investing when others are seeking safe havens and taking risk off the table when others are bullish, sounds obvious. It is what Warren Buffett describes as being ‘greedy when others are fearful and fearful when others are greedy’. But it is simpler to say than to do.

I was reminded of this by the Bank of America’s latest fund manager survey, published this week. It is one of the most rose-tinted views of the market outlook that I have ever seen. Serious professional investors, managing billions of our savings, are drinking the Kool Aid as never before. This worries me.

Here are some of the highlights of the January survey. Overall investor sentiment is the most bullish for three and a half years. The amount of cash being held in reserve by fund managers is the lowest as a percentage of the assets they have to invest since at least the late 1990s.

The proportion of fund managers expecting profits to improve over the next 12 months is the highest since July 2021. A negligible 9% of investors expect a recession in the next year. More than two thirds did as recently as April last year.

The balance of investors favouring riskier assets like shares and commodities over bonds and cash is right at the top end of the range for the past two decades. Fund managers have more cyclical banks and fewer defensive consumer staples stocks in their portfolios than at any point in the past 25 years.

I could go on. But the numbers all point the same way. Investors may think markets are high - 40% say AI shares are in a bubble, a net 45% say gold is overvalued - but they are not doing much about it. A net 16% are taking ‘higher than normal’ risks compared to their benchmark. Over the past two decades, that has only been exceeded during the exuberant recovery from Covid. The number of investors using financial instruments like options to protect against an equity correction is the lowest since 2018.

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On the face of it, this looks like a curious response to everything else that’s going on in the world. And we cannot even blame the timing of the survey’s fieldwork - investors were quizzed between the 9th and 15th of this month. They knew about Venezuela. Greenland was on the radar, albeit the latest tariff escalation had not yet muddied the waters. Davos was waiting in the wings.

I do not really blame the investors. ‘Buy the dip’ optimism has been an effective strategy over the past year. The recovery in share prices since the 20% correction between February and April last year has only been bettered once - in 1998. The speed and scale of the bounce since last year’s tariff tantrum is a salutary warning that markets often scale a wall of worry. Perma-bears can regret their scepticism - in the short term, at least.

It is not how I am investing, though, in the face of what looks to me like an unpredictable, fragmented world in which the power of law has been replaced by the law of power. A world in which investment risks are rising and projected returns look lower than we have become used to in the past few years.

Specifically, there are five things that I am using the market’s strength over the last nine months to put in place.

First, I am going all in on active management, rather than passive tracker funds. It will not remove the sting of a market correction completely. But I would rather my fund managers are at least trying to pick the winners and avoid the losers when things get sticky.

Second, I am maxing out the geographic diversification of my portfolio. The events of the past few weeks will only accelerate the rotation out of US assets into the rest of the world. Wherever the money goes, I want to be riding the same wave.

Third, I am focusing on income. Whatever its source, a high yield will smooth the volatility I expect on the road ahead.

Fourth, I am seeking ballast for my portfolio. With higher correlations between shares and bonds, as trust becomes scarcer, I am hanging onto my gold, keeping a good cash buffer, and looking to add to my infrastructure and real estate holdings and to explore absolute return and market neutral investments.

Finally, I am preparing for an extended period of dollar weakness. That will involve holding less in America and more in investments that typically benefit from a fall in the US currency - commodities and emerging markets.

Part of me hopes the fund managers surveyed by Bank of America are right and I am wrong. But I am not counting on it.

This article was originally published in The Telegraph.

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