Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
The long-term outperformance of shares is a reward to investors for the uncertainty they have to endure along the way in this most volatile of asset classes. You will have earned less historically with bonds and cash but you’ve probably had a less stressful ride.
This week has been a textbook example of how volatile stock markets can be when investors start to reassess the truths that have served them well in the recent past. For years now, backing high growth technology shares - the likes of Amazon and Apple - has made investing look easy. You would be forgiven for feeling less certain of things today.
On Monday, the Nasdaq index - which includes many technology stocks and is a kind of proxy for their performance - suffered a sharp sell-off. It capped a dismal period for high-growth shares, taking the drop in the Nasdaq index to more than 10% since mid-February. That’s the common definition of a stock market correction.
But on Tuesday, everything bounced back. The Nasdaq was up 3.7% on the day, outpacing the broader-based S&P500 index, which rose by 1.4%. It was the best day for the tech index since November. Please remember past performance is not a reliable indicator of future returns.
Some investors will have breathed a sigh of relief, concluding that the market sell-off over the past month or so has now run its course. Perhaps it has. But it pays to look at the underlying reason for the change in market leadership before dismissing the possibility that it has further to go.
As has been widely discussed elsewhere - including in my latest weekly market update - the problem is, counter-intuitively, the strength of the expected recovery from the Covid pandemic. Such has been the scale of financial support, so apparently successful has been the vaccine roll-out, and so great has been the opportunity for some people at least to put aside more savings than usual, that the big fear today is not too little economic activity but too much.
The positive view of the pandemic was always that it would be a short-term hit to the economy, followed by a rapid, V-shaped bounce. All the evidence is that this is what is happening. And the associated worry is that nervous governments and central banks will fail to withdraw the punchbowl of stimulus before it has stoked a return of inflation. In some ways, the news is just too good at the moment.
The reason why this has hurt Nasdaq so much in recent weeks is that the valuations of the companies it specialises in - companies expected to grow long into the future - are dependent on the continuation of low interest rates. Their future earnings are worth more to investors today because they are discounted back at a low interest rate. Were those rates and the bond yields that reflect them to rise then the value of those earnings today would fall.
That is a bit technical. But it is very important for investors because so much of the overall level of the market is today determined by the value of those high-performing shares. If Nasdaq sneezes there is a danger that the rest of the market catches a cold.
The volatility in markets this week is an indication of the tug of war between those investors who think we will soon revert back to the old growth-focused investment style that has worked so well since the financial crisis and the value-focused investors who believe that we have reached a watershed, with more cyclical shares like energy stocks and banks picking up the leadership baton from the giants of Silicon Valley.
One of the key unknowns this week is whether the US government can persuade investors to continue buying the bonds it issues at historically low yields. Typically, if appetite for bonds starts to falter, their yields need to rise in order to attract new buyers. With $120bn of bonds on offer this week, the stage has been set for a stand-off between the Treasury and the so-called bond vigilantes who always test the authorities’ resolve.
So far, so good. The Treasury was able to sell the first $58bn tranche of short-term three-year bonds at a yield of just 0.355%. There was demand for more bonds than were on offer. That augurs well for this week’s further sales of 10-year and 30-year bonds.
With so much uncertainty, however, the need to protect our investments has never been more important. The best and easiest way to do this is to ensure that your portfolio is well-diversified. Make sure that you are exposed to a good spread of asset classes, geographical regions, investment styles and asset managers. That is the way to enjoy a smoother ride and to navigate any potential market volatility.
My fund picks this year were selected with just this kind of uncertain environment in mind. I have picked five funds across a range of markets, with exposure to both shares and infrastructure (a good source of income and a better protection against inflation than bonds). There is a focus on sustainability, which has been shown during the pandemic to protect returns in both good and bad market conditions. I have tried to include a spread of investment styles too, so that investors are not caught out by any swing from growth to value or back again.
You can read more about my five fund picks here. And don’t forget that the tax year ends on Easter Monday, the 5th April. The ISA contribution allowance (up to £40,000 for a couple) expires at midnight on that day. It is a ‘use it or lose it’ allowance so please don’t be caught out by the holiday period - the best way to ensure you take advantage of this generous tax break in time is to invest online and avoid the ‘pandemic post’.
Five year performance
|(%) As at
Past performance is not a reliable indicator of future returns
Source: FE, total returns in GBP terms as at 9.3.21
Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Tax treatment depends on individual circumstances and all tax rules may change in the future. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
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