Is it time to adopt a more conservative investment approach?
I admit that I'm a pessimist but I'm beginning to be more nervous than normal about the markets.
I buy the idea that the quantitative easing money has gone via financial institutions mainly into various kinds of assets and made them more expensive than they deserve to be. The outlook hasn't seemed so gloomy for most of 2009; the panic really did seem overdone earlier on so the talk of a dead cat bounce and, later, of a bear rally was unconvincing.
So, why can't the good times roll on? They might, a downward turn may not happen but the assets that have done best have been liquid ones. The two main exceptions to this have been emerging markets, but those economies really are in better shape than developed ones, and commercial property. In the case of the latter, talk of recovery is only very recent and may not amount to much more than some London-based financial institutions deciding they can loosen their belts at the end of a good year.
If the success stories of 2009 are all liquid assets, the success could easily go into reverse.
Time for pessimism or time for panic
Given that so many commentators are ready for stock market indices to turn downwards and that until now institutions have been leveraging less than they used to in the good old days, it should just be a correction, not a rout. Even though the financial world is still traumatised it feels as if we've learned a lesson about asset bubbles.
One psychological factor that could make a stock market correction more serious is the groundless expectation that the recovery has to continue until investors are back where they were in, say, 2007.
For the long-term index tracking investor expectations of a turning point can turn into a testing time. Are their existing choices of funds good enough to take the rough with the smooth or are they thinking of going up on deck to check that everything is as ship-shape as it can be?
Personally, I admire a buy-and-hold investing strategy but don't follow it unflinchingly. Some ETFs look to be good for years ahead while other investments could do with adjusting.
In the former category I'd include some emerging markets, some themes such as iShares S&P Global Water (LSE: IH20) and some sectors such as healthcare or food.
In the latter category would be bullion ETFs like Gold Bullion Fund (LSE: GBS), which seems to be losing some of its hedging qualities in the general run up in asset prices, and, as I said a few days ago, selling some funds that track cap-weighted indices and investing in ones that track fundamentally weighted indices or aim to capture the best dividends such as iShares Dow Jones Euro STOXX Select Dividend (LSE:IDVY).
Income driven
The keyword to this approach is income, instead of growth. So, does it make sense to switch into fixed-income ETFs as well? Just on the expectation of a stock market correction, the answer would be no, but trying to predict other relevant factors such as changes in inflation and interest rates is a lot harder.
The Monetary Policy Committee's tricky job of anticipating inflation increases with corrective interest rate increases has become virtually impossible now. From the middle of 2010 until the end of 2012 the Bank of England Inflation Report has a forecast inflation rate that could be anything from less than 0 to over 4%.
It looks as if there'll be an increase in inflation and that doesn't sit well with the mass of predictions that interest rates are going to stay low for many more months. Indeed, anything more than a fairly modest increase could lead to intolerable pressure to recast the rules the Monetary Policy Committee works under.
In these circumstances, I'm still be interested in ETFs tracking corporate bond indices such as iShares Euro Corporate Bond (LSE: IBCX) or iShares GBP Corporate Bond (LSE: SLXX). The former looks particularly attractive if you believe that euro is going to stay strong or grow stronger but an investor would need to be sure they could wait out any surprise spike in the value of sterling. The sterling corporate bond could also benefit as corporations had to raise the coupon on their new debt securities.
Given that there's probably some inflation just over the horizon and it's not certain if or how it will be dealt with, I'm less keen on government bond ETFs, even index-linked ones. An ETF like iShares GBP Index Linked Gilt (LSE: INXG) looks overpriced; it would be safer to pick up a leaflet about index-linked National Savings from the Post Office.
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Francis owns IBCX, GBS and IH20.
