Are equity markets too expensive?
And how well diversified are you?
Many stock market valuations are certainly not cheap, nor have they been for some time. One popular measure of valuation of the US S&P500 stock-market index is the CAPE ratio. This shows the current price of stocks as a multiple of earnings (10yr average, adjusted for inflation). Using this measure, US stocks have exceeded current valuations only twice in history ; just before the 1929 crash and at the peak of the dot.com bubble.
However this is not a new development. Market bears have been pointing to this chart as a signal for a market correction for more than a year.
The situation in Europe is a little different but keeping a close eye on the US is important as it accounts for >50% of global stocks and impacts on markets globally.
Despite what some people might claim, predicting short term moves in stock prices is close to impossible.
For most investors diversification is key. Those who hold all of their assets in equity markets have done well in recent times, but should be aware of the potential risks. When markets turn, they tend to turn very quickly.
What do we mean by diversification?
Diversification may mean different things to different people. Basically diversification means that you spread your investments over different asset classes and geographies, thereby reducing exposure to one particular type of asset or risk. This may mean stock market investments in developed and emerging markets. It may also include allocations to some mix of government bonds, credit, property, real assets, cash, precious metals and more. The exact split will depend on the individuals risk appetite and other factors.
Be aware of what you own
Individual investors typically invest their pension or savings portfolios in investment funds. If you’re in this camp, make sure you review your investment funds regularly. This is not simply to monitor performance and costs, but to check if the investments are still right for you. Do you know what exactly your funds are invested in? You should.
Contrary to reports of it’s demise, active management is not dead. Passive has been king for the 8+ years since the global financial crisis and stock-market lows of March 2009. Using the broad US S&P500 index as a benchmark (see below), buying the index for the lowest possible fee and riding the uptrend has worked beautifully.
S&P Dow Jones Indices LLC, S&P 500© [SP500], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/SP500, June 26, 2017.
However bear in mind that during this time-frame, global Central Banks cut interest rates to all-time lows and pumped trillions of euros/dollars/sterling/yen into the economy via ‘Quantative Easing’. This is not the only driver of market performance but has certainly been a contributing factor.
We must contemplate what might happen when interest rates start to rise (as is happening, albeit at a slow pace in the US), and what happens when the central banks start to shrink their balance sheets.
Now might be a good time to review your investments
Kudos to you if you have owned the so called ‘FAANG’ stocks this year. Facebook, Apple, Amazon, Netflix and Google account for a significant part of the returns in the main US stock indices, and are almost all you hear about in the financial media.
Of course most investors do not own these names on their own, rather they invest in funds whether traditional managed/passive funds or ETFs.
But if you do own some of the recent hot stocks….
While we do not provide advice on individual stocks, let’s just say that forward valuations based on current prices look ambitious.
Long term approach
Valuations alone cannot predict corrections or future market returns. However higher than average valuations suggest lower return expectations for the next number of years.
Attempting to time markets is not something we try to do, simply because of their unpredictable nature. However it may be prudent for those with concentrated exposure in stocks to consider their risk exposure with volatility so low, the US Central Bank starting to ‘take away the punch bowl’, and arguably expensive valuations. Additionally just owning a portfolio of individual stocks leaves a portfolio seriously un-diversified
How well diversified are your pension or direct investments? We advocate a detailed portfolio analysis at least annually at which point some re-balancing may be in order.
Gold – Good diversifier?
In the long run gold tends to offer uncorrelated returns and insurance protection. At €1,100/oz gold is arguably not that expensive, especially considering valuations in many other asset classes.
Cash in Europe is still paying close to 0%, meaning the ‘opportunity cost’ of owning gold remains low.
Cryptocurrenties have been all over the news in recent months. The technology behind the likes of Bitcoin may be a long-term game changer. However the recent volatility in price of a bitcoin means it cannot be said to be a good store of value (Sub $1,000 as recently as March, almost $3,000 in mid-June and $2,200 at end-June). Call me old fashioned but as a diversifier I would prefer something more tangible.
This is not an alert to go out and sell equities today, but it’s always a good idea consider the risks in what you own and how well diversified you are.
We work with all of the main providers of savings and investment products in Ireland. We would be delighted to meet and discuss your financial needs whether it’s a regular savings plan, lump sum investment or retirement planning.
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Wishing you an enjoyable summer break, hopefully some good weather and fun times with friends and family!
Ardbrack Financial Ltd
Disclaimer: The content of this article is for general information purposes only. It does not constitute investment advice as it does not take into account the investment objectives, knowledge and experience or financial situation of any particular person or persons. You are advised to obtain professional advice suitable to your own individual circumstances. Ardbrack Financial Limited makes no representations as to the accuracy, validity or completeness of the information contained herein and will not be held liable for any errors or omissions.