What’s Hot, What’s Not?

Apart from the weather, some investments are hot and some are cold. Of course I am referring to current buying and selling trends by investors. These trading decisions should be based primarily on economic and investment fundamentals but often sentiment and investor psychology is a key reason why investors trade. This is not always logical or proportionate. That said there are contrarian investors,  counter intuitive mavericks who refuse to accept the consensus view or follow the herd instinct. In this blog I comment on various asset classes and explain a few asset allocation changes I have recently made to my own investments.

Gold is definitely cold, having suffered a vicious sell off in April on fears that Cyprus may have to sell its gold reserves, thereby setting a precedent for other indebted countries of the EuroZone.  Other factors such as muted inflation, signs that money printing which debases currencies might be coming to an end, notably in the US, and profit taking after a 12 year bull market also contributed to the negative sentiment. In my view the sell-off may have been overdone and long term gold should form a small percentage of most investment portfolios as a hedge against currency debasement and future inflation. The problem with gold is that it pays no income and is hard to value on a fundamental basis, unlike equities. Consequently sell offs when they come are often very quick and sharp.

At the other end of the temperature gradient Japanese equities are very hot. With strong central bank and government intervention to tackle Japan’s deflationary woes such as an inflation target and money printing and asset purchases the yen has weakened significantly. This has sent equity prices rocketing. Not only are Japanese exports cheaper, overseas assets priced in foreign currencies have been repatriated back to Japan to benefit from the favourable exchange rate. Some of this at least will have been invested in Japanese companies including domestically oriented smaller ones. Two months ago I wrote about Japan in an investment blog and reported I had invested into the Legg Mason Japan Equity fund. This invests significantly in domestically oriented small caps rather than the mega cap exporters. It is a highly volatile fund, a client once described it as a kamikaze investment. I am pleased to report my high risk trade was successful and I cashed out a 50% profit in less than three months. I retained my original investment amount in case the rally continues.

I have since re-invested the profits into a natural resources fund, another very oversold sector. There are various reasons why miners have had a torrid time in recent years. It is the most economically sensitive sector of global stockmarkets and with anaemic growth in the EuroZone, slowing demand and economic growth from emerging markets, notably China, rising commodity production costs and poor allocation of capital the decline of equity prices has been sustained over the last five years. I have taken a contrarian view based on the fundamentals of favourable long term supply and demand dynamics and excellent valuations and have invested some money into resources funds. I am not expecting a quick rebound but when it comes I reckon I’ll make some money.

The bond market remains highly complex and diverse. In the past I thought bonds were boring. High yield and index linked bonds remain the most attractive asset classes in my opinion. High yield bonds have enjoyed a strong rally since the financial crisis when spreads between their yields and those of safe government bonds spiked to historic levels. Falling yields since have provided investors with strong capital gains. Looking forward returns are more likely to come from the yields and although these are relatively low they are still attractive compared to cash and inflation especially with the tax benefits from being held in an ISA.

Index linked bonds, although expensive, are a buy for me for protection against future inflation. Most investors are sanguine about the threats here. I can’t help thinking an inflation shock will occur at some point. It may come from a surge in the global economy or the effects of money printing (or quantitative easing) with loose monetary policy by central banks. There is a clear shift in policy here with remits moving from controlling inflation to stimulating growth and employment. Index linked bonds, mainly issued by investment grade economies such as the UK and the USA provide returns of capital and income in excess of inflation.

Finally I remain positive about global emerging market equities despite them being off the radar of many investors. These have underperformed developed markets in the last three years. Figures from Morningstar to 12/4/13 show the average IMA Global Emerging Markets fund returned 7.9% over one year and 7.5% over three years. Contrast this with the average IMA UK All Companies fund of 19.4% and 29.1% respectively. There are many broad and country specific reasons for the sluggish returns from emerging markets. In “risk off” markets money flows from perceived high risk positions to safe havens whilst commodity exporters such Russia and Brazil have languished. China is suffering from fears of a property and credit bubble. Other factors include declining investment and poor corporate governance.

In summary I can see a theme in the investments I favour – gold, commodity equities, index linked bonds and emerging markets. All should be beneficiaries of global economic growth and inflation. The higher risk investments can be accessed by more cautious investors using monthly savings plans although depressed sectors have a particular premium from lump sum investment if there is a subsequent rally.

The content of is blog is for your general information and use only and is not intended to address your particular requirements. The blog should not be relied upon in it’s entirety and shall not be deemed to be, or constitute, advice. You should seek individual advice before making investment decisions.

The IMA is the Investment Management Association which groups funds with similar remits into various sectors.