European stock markets have rallied today. As I write the FTSE 100 is up 2.29%. Up to now it was the case that “shares can go down as well as down,” so today’s rise is a welcome respite. However it could prove to be a dead cat bounce, a temporary relief rally with no life in it. (No cats were harmed during the invention of this analogy). The fact that the banks have come under pressure in this current crisis is a real concern and wholly unexpected on my part. This is likely to ensure ongoing negative investor sentiment.
Whilst all the focus has been on the sell-off in global equity markets, investors should bear in mind that traditional safe haven assets have risen strongly, notably gold, government bonds and the Yen. Bloomberg reported that benchmark 10 year gilts fell yesterday to their lowest yields since 1989. You need to remember the relationship here, if gilt or bond prices rise yields fall. Investors gain from yield compression with higher capital values. They also continue to receive the same fixed interest payment or coupon. The apparent anomaly between fixed interest and falling yields is explained below in a technical note.
According to Investment Week the spot price of gold has risen 16% in 2016 and this has fed through to gold producers’ share prices. This has been interesting to observe as in previous recent sell-offs gold seemed to have lost or forgot its safe haven status. However every silver lining has a cloud – the recent rally in gold may signal that investors are really jittery.
The Yen’s rally means investors in Japanese funds without a currency hedge, (my asset allocation choice in recent years) benefit from the exchange rate. However Japanese equities have been especially hit hard as a strong Yen is a headwind for its exporters and global companies with strong overseas earnings. The resulting losses from equities in local terms have more than wiped out the currency premium for UK investors.
The Japanese central bank will be dismayed by this Yen rally and could take further action to extend QE. Aside from lower company earnings Japan is more likely to miss its inflation target as it imports lower prices.
In conclusion although Yen strength has created new problems for investors, portfolios that include gold and fixed interest such as gilts will have had some protection. The role of complementary and defensive assets in portfolios has come sharply into focus .
Finally managers of targeted absolute returns i.e. that seek but not guarantee to make money in all market conditions will have earned their salaries if they have achieved this in the last month. You may recall that they do this by using derivatives, effectively shorting stocks and indices. This means when stocks fall a targeted return fund can make money. On checking performance data from FE Trustnet today over one month the average Investment Association (IA) Targeted Return fund lost 1.6%. However a number of funds delivered positive returns including the Newton Real Return which quite a few of my clients hold. This rose 2% in the last month. Another favourite the Invesco Perpetual Global Targeted Returns fund was down 0.4%, less than the -1.6% sector average but still down. However compared to equity markets these losses are relatively small and demonstrate that even if absolute returns are not achieved losses should be capped.
Technical Note: Consider a gilt or bond issued at £100 with a fixed interest payment or coupon of £3 p.a. or 3% p.a. If an investor buys this bond at outset they receive £3 p.a. for as long as they hold it. If demand in the bond market increases the price to say £110 and the investor sells, the new acquirer will receive the fixed interest of £3 p.a. but the yield they would have bought at is less than 3%. The yield is £3/£110 x 100% = 2.73%. So when prices rise in the bond markets the yields fall, and vice versa, but the attaching coupon is fixed. Hope that is clear.
The contents of this post are intended to be my own general investment commentary and not an invitation to invest in safe haven assets or targeted return funds as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.