As many remind us on a continual basis, the current rally enjoyed by US equities is the longest in history.
The fair winds of monetary stimulus from central bankers and prevailing low interest rates have helped steer the virtually unceasing rise of the S&P 500 index into the history books. But its sheer length, close on 10 years, is making some investors nervous and rightly so.
Confidence was severely buffeted at the back end of 2018 as global growth downgrades, trade spats between the US and China, and the US central bank’s tightening interest rate policy made for choppy waters.
Consequently, investing in bond and equity markets proved anything but plain sailing. A change of tack in US central bank policy, in January 2019, whereby further US interest rate rises were put on hold, led to something of a recovery in markets.
Sentiment remains fragile
The reason why investors may be finding it hard to navigate their way through financial markets is simple: no one is certain as to where we are in the current economic cycle.
While ‘typical’ cycles last anything between three and five years, this one is notably more prolonged. The stage of the cycle is important because slowing rates of growth across regions and countries impact asset classes in differing ways.
For example, as profits reach their peak, the focus of investor attention is typically on high quality companies with strong, recurrent revenue streams, healthy finances and resilient business models.
Holding these types of stocks as the cycle matures is in sharp contrast to those investments which typically perform better at the start of an upturn in the economic cycle. During this phase, investors might generally favour smaller companies and economically sensitive stocks such as house builders and other consumer-related companies like retailers and automobile groups.
In a world where global growth is slowing (although still expanding) investors need to be more differentiated and flexible with their portfolios than if they were positioned at the earlier stages of the economic cycle.
History has also shown that as the economic cycle reaches maturity, prices of bonds and stocks tend to ebb and flow more widely. Although market dislocations may cause concern, they can provide opportunities.
Certain types of investments tend to weather a downturn better than others, such as those companies that pay meaningful, sustainable dividends, so providing investors with a steady income ballast in the event that they experience capital losses. Be mindful, however, that not all dividend payers can maintain their existing rates of dividend pay-out.
Investors need to identify those companies with good cashflows and which can offer a steady return potential.
Government bonds can also act as a portfolio buffer and navigate fluctuations in share prices. Again, the key is to be selective and focus on those that offer an element of diversification away from stocks.
Stay diversified and be selective
Building more resilient portfolios ahead of potential economic slowdown, however, needs careful thought. Investors who are overly defensive can undermine their long-term goals of aiming for capital appreciation and income growth from their investments.
And, of course, there are those who believe that the current economic cycle will run for some while longer. While the era of historic low interest rates may be drawing to a close, any further US interest rate rises are likely to be gradual for the time being. Fears of aggressive US interest rate tightening acting as a brake on the global economy have, for the moment, abated.
Given the uncertainties in stock and bond markets generally, diversification is always a prudent tool for encountering potentially stormy seas – the old saying, “do not put your eggs in one basket” springs to mind. Stay diversified and, above all, be selective. And as tempting as it is to try and time market corrections through aggressive buying and selling, those investors who ride out the market ups and downs will, generally, fare better than those who do not.
Ritu Vohora is equities investment director at M&G Investments.