Following up on my major stock market call, I'll be examining the various ways we could protect ourselves from a potential financial accident, whilst also uncovering one or two options for those inclined to take a punt on plunging prices. There are also a few thoughts on strategies for pension investors and for those who own stocks&shares ISAs, plus as a few words on what evasive action you could take before the upcoming emergency UK budget.
STOCKS
ONE TO TWO MONTHS
I'm reluctantly reversing my previous 'green-light' update of May 23rd. There is, in truth, a decent chance we will find a temporary low over the next week or so and rebound towards 1120 - 1140, maybe even higher, on the S&P500. But there is also a risk, as the last two weeks have shown, that from here we simply can't find a strong enough foothold to maintain any gains and keep on slipping. This is the fatal 'Slope of Hope' which kept investors in the market right up until the crash of October '08; so with potential upside limited to the April highs, and with all the other technical evidence (as detailed in this month's main post) pointing lower, I see little value in hanging in there except to make very short term trades. On which theme, once the market has begun to decline more sharply I'll be inclined to go short* until the S&P500 hits 1014, its approximate 38.2% retracement of the advance from March '09 to April '10. But if over the next couple of days markets stabilize and edge up, I'll wait for a clear signal that the market is topping out before piling on.
If that scenario materializes, I'll make the call in a blog update.
Once the eagle has landed at S&P 1014 we'll likely see at least a bounce, so I'll be looking to take profits there and await the next opportunity. Good candidates for trades include Brazilian stocks (which are already in a true bear market and are being pulverized from the carry-trade unwind) through an ETF (Exchange-traded Fund) such as Proshares UltraShort Brazil which tracks their equivalent of our FTSE100, and also the US Russell2000 stock index (through Proshares Ultrashort Russell2000 Growth), an index of small companies which has seen wild speculative inflows now being spectacularly up-chucked.
'Ultra' ETFs are 2x leveraged, so any daily movement of the index one way or the other is doubled. These types of investments are to be entered on a strictly short term basis - a few days at most - as if they turn against you your account can get munched unless you exit promptly.
*A 'long' trade is one in which an investor's expectation is for a particular market to rise, 'short' positions are placed to profit from a market decline.
'Ultra' ETFs are 2x leveraged, so any daily movement of the index one way or the other is doubled. These types of investments are to be entered on a strictly short term basis - a few days at most - as if they turn against you your account can get munched unless you exit promptly.
*A 'long' trade is one in which an investor's expectation is for a particular market to rise, 'short' positions are placed to profit from a market decline.
THREE TO TWELVE MONTHS
With technical danger signals flashing all about us, I see no reason to stay long of stocks over the medium term. I do see some potential, however, on the short side. As a rule I'd avoid leveraged ETFs which are really only safe for quick trades, but a plain vanilla short position in, lets say European banks could be a spectacular winner over the next several months, even if they have already suffered a fair bit since April. Established ETF provider db x-trackers offer a product on this theme, the Stoxx600 Banks Daily Short ETF, which I'm considering putting in my ISA.
There's an important point worth remembering here if you're trying to decide whether to hang on to any of your stock positions. An investment in a short ETF of this type can simply act as insurance, a hedge, for your long positions. You'll need to do the sums carefully to balance your upside and your downside but then, once the longer-term direction of the market is clear you can sell whichever is the losing position and remain on the right side of the trend.
Further smart options for protection include covered warrants, which offer clearly delineated risks and potentially high rewards. Here's a guide from Investor's Chronicle.
ONE TO THREE YEARS
There will come a point when this decline is deep enough and far enough along to consider making a substantial investment for a longer term upswing. That point, however, is not in sight.
BONDS
As this recent market downturn has unfolded, investors have fled back into the perceived safety of government bonds. Here's that fateful chart of the US ten-year treasury bond I posted here a couple of months ago, updated:
The 'inverse head-and-shoulders' pattern I identified, which was set to propel rates up towards 6%, broke down spectacularly as investors, battered by storms in the stock market, ran to take cover under Uncle Sam's top hat. This was repeated in the UK, where yields on 10-year gilts fell to around 3.6%. The question now is whether the trend continues. Fortunately we don't have to guess.
Technically, if yields break below this point (3.2%) there's every reason to expect a swift move down across the board to 3% on the US 10-yr note. This would accompany a sell-off in stocks. But if they reverse here, yields still have a shot at fulfilling that head-and-shoulders pattern and shooting up towards 6% (OK, I admit I'm clutching at straws). It does seem that the only way such a scenario could now play out is if there was an all-out sovereign debt crisis in which investors began a wholesale sell-off of government bonds.
Barring that eventuality, we're faced with a remarkable possibility: that we've seen the peak in bond yields for a long time to come.
Barring that eventuality, we're faced with a remarkable possibility: that we've seen the peak in bond yields for a long time to come.
This is big news, folks. It means deflation.
It means low mortgage rates.
It means low savings rates.
It means a possible repeat of the slow grind into the dust the Japanese experienced in the 1990s...
Japanese bond yields fell virtually without respite following their bust in 1990. 10 yr bonds will today earn you under 1.3%. Tempted?
And it means it won't be long before we'll need to get busy locking in these yields on gilts and treasuries, because they could soon fall even further. One instinctively gags at the thought of 'locking in' a sub-4% rate of return - yet if deflation kicks in as it did in Japan, 4% will seem like heaven's bounty in a few years time. I'll be doing some more research on this over the next few weeks and will update here.
For now though, government bonds should continue to serve as a safe-haven if stocks fall as long as sovereign debt risks remain contained. If a European debt crisis erupts, mayhem could ensue with investors selling bonds first and asking questions later. For that reason I'll be restricting my focus to those countries furthest from the 'Ring of Fire' (see my earlier post) ie. those in northern Europe, Germany, Canada, South Asia and possibly the US.
High-yield junk bonds have been selling off in the market turmoil, but investment-grade UK corporate bonds have held up well so far. Long-term however, signs are that the market may be topping out. Here's the ishares UK Corporate Bond ETF which, tracks the top 40 UK securities and is a good proxy for the overall market:
ishares £ Corporate Bond ETF since 2004 - stalling out
Returns have basically been flat for eight months, and the index has dropped below its 200-day moving average. If the outlook for UK growth palls - which I think is virtually nailed on - corporates will struggle to hold their value.
PROPERTY
- The UK market is now showing clear signs of a slowdown
- Mortgage lending continues to fall as banks tighten the screws
- The end of UK Home Information Packs, amazingly enough, spurs a massive jump in supply
- Supply has already increased in London, capping price rises
- Financial journalist Merryn Somerset Webb, long-time housing bear, can stand it no longer and capitulates, signalling the top of the market
- US home prices resume downtrend, even as mortgage rates fall
Case-Shiller Home Price Index for 20 leading US cities
- US building permits, a leading indicator, suggest more pain ahead
- For anyone who thinks the Australian property market is not in a bubble - an open invitation to short ING
COMMODITIES
- Barring an immediate sovereign debt panic, the prospects for gold and silver are, in the short term, dodgy
Do not buy precious metals at these levels, folks.
- Commodities such as oil have been hit by the soaring dollar and carry-trade unwind:
Oil falls under its 200-day moving average
- Their drop is not a good omen for worldwide growth
- Interestingly though, one reliable technical signal (for fellow nerds, DeMark Sequential) suggests the dollar may have peaked for now - which should provide support for the commodity complex. If underlying demand is real and healthy, price rises will follow. If not, it will be a clear signal that the best for these instruments is behind us.
- China is now well into bear market territory, as property and inflation worries gain traction. Even if one discounts the possibility of a property crash, prospects for commodity gains with China slowing are in question.
Downward sloping 40-wk average means the bear is back in China
CASH & SAVINGS
If you've been gradually shifting out of stocks and into cash over these past few months as I've been suggesting, you'll be sitting pretty smug right now. As I proposed in the March Outlook, I'm confident cash will be the very best place to sit tight while markets get roiled over the next year or two. Boring, but hey, I'd rather sleep at night.
My plan is simple.
Move as much of my savings and investment funds as I'm confident I won't need short term into
- the highest long-term fixed rate savings bonds available which would allow me to withdraw my deposit before the expiry of the fixed term, even at the cost of forfeiting some interest
- Long-term fixed-rate or high-interest cash ISAs with the same flexibility
- Relax.
My baseline expectation, currently being foreshadowed in the bond market, is that savings rates will move down over the very long term, confounding consensus predictions.
Pundit forecasts of rising or hyper inflation are unlikely to materialize due to the mighty forces of debt deflation now at work. Until this process ends, injections of central bank cash will fail to ignite price rises, as Japan's long experience clearly shows. In fact, latest figures show US money stock declining at the fastest rate since the Great Depression, just as it did before the crisis of 2008. This is a powerful indicator of deflation ahead.
But you'll see that I have a get-out clause built into my strategy in case I'm wrong. If, as I've been half-hoping for, savings rates spike higher - perhaps due to a euro debt crisis and major bond sell-off - I will be able to withdraw my deposits from these fixed-rate savings accounts and find a better yield. The cost of forfeiting some interest is likely to be less than the long term gain from switching to a much higher rate.
On a side-note, there are currently a few wild geese on the run out there called 'structured products'. Folks, think twice before chasing them. Offered by the big banks and insurance companies, they go by names like 'FTSE Guaranteed Growth Plan' and offer high rates of return linked to future stock market performance; unfortunately any return depends on a certain level of performance being met (and on actually getting paid) whilst most plans are riddled with company caveats, evasions and small print which stack the odds against the investor. I'd personally file them under 'if it looks too good to be true...', but check this guide first if you're still tempted.
If you are prepared to consider an outside-the-box idea to make a higher return - and there is risk involved here - one interesting option should be profitable and might even be highly worthwhile from an ethical standpoint.
Check the side bar to the right for links to savings rate comparison sites in the UK and US.
A WORD FOR
PENSION INVESTORS
Many pension plans don't specify in their basic literature what particular vehicles they will be investing in. Frankly, most people are content to leave this to their pension provider. When you signed up, you may simply have been asked to complete a 'risk profile' to decide whether you ought to be in racier or more conservative types of investment.
For twenty years up until 2000, high-risk pension investing paid off spectacularly. All pensions offer a degree of diversification to limit your risk, but these plans would likely have had a heavy weighting towards stocks, high-yield bonds and, for example, commercial property. The last ten years these would have suffered hugely and a tilt towards ultra-conservative investments would have kept your head above water - government and top-quality corporate bonds and of course cash.
You might not know that many pension providers allow you to switch between the various levels of risk as you please, either for an admistration fee or completely free of charge. Ideally, since March 2009 your pension plan will have been skewed towards those riskier asset types which have seen substantial gains through April this year. But it's extremely unlikely that these will continue to perform as they have and it's these which were hammered most mercilessly in the recent sell-off.
If you're not sure what types of investment your pension is being allocated into, I'd suggest finding out as a matter of urgency. If your plan includes a high percentage of stock market investments compared to bonds and cash, I would consider reversing that weighting immediately; if you cannot specify in this way, consider switching as soon as possible to the lowest available risk category your plan will allow. Even if there is an administrative cost involved it may be worthwhile, such are the dangers that lie ahead.
When markets have either proved their strength - ie. by breaking and holding above their April 26th highs for an extended period - or else they have been beaten down substantially until they become cheap and unloved once again, you can always return your pension to a riskier and more growth-orientated weighting. This is the treacherous and topsy-turvy new market environment we are now in, folks: advisors are taught to recommend leaving your pension untouched, but as the last decade has shown, taking cookie-cutter financial advice has become a risky business.
A WORD FOR
STOCKS & SHARES ISA INVESTORS
Sell.*
*If you wish, you can simply leave the proceeds from any sale sitting in cash within the ISA wrapper. You'll be able to reinvest it as you wish. A plain vanilla bond fund which invests in the most solid government bonds (eg. 'M&G Corporate Bond Fund') or US Treasury bills will be your next safest bet. Markets may edge up for the next few days and weeks, tempting you to hang on. But beware. Don't wait for a market crash and then sell in panic - by that time it will be too late.
EMERGENCY BUDGET 22nd JUNE 2010
Son of Dracula (excuse me, I meant to say the Hon. George Osborne MP), our pallid new Chancellor of the Exchequer, will stand at the dispatch box on 22nd June and reveal how he plans to drink the nation's blood (excuse me, raise our taxes).
Here's the potential headline damage:
- A rise in capital gains tax from 18% to 40% or 50%
- A rise in VAT to 20%
- The Labour govt's rise in NI contributions for workers - though not for businesses - will go ahead
I would also expect a blizzard of smaller tax rises to inflict almost as much pain, in a process of death by a thousand cuts.
There has been an outcry from the Tory backbenches at the capital gains tax proposals (well, you put it in your own manifesto, boys), so what may well happen is that long term capital gains may not suffer so badly, but short term gains will be walloped. For example, a second home held for more than three years may be taxed in the same way as now, but anything owned for less than that period will be hammered at a flat-rate 40%. This would represent a big hit if you'd counted on being taxed at 18%.
It's probably too late now to sell a house before the Budget, but you can surely sell your stock holdings. In fact you could do so, realizing any gains over your CGT allowance at 18%, and then simply buy some back within an ISA (though you'd better have a damn good reason to buy them back if my market forecast is right...)
If you're planning a big purchase - say a new TV or piece of furniture - shift your rear end down to the shops pronto, because there's no doubt a VAT rise would come into effect immediately it was announced.
Here are some extra thoughts from the personal finance pages on ways to avoid the Chancellor's fangs.
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That's your dose for this month, folks. I'll be back with your free disaster-navigation guide right here on July 4th - and US friends, you don't need me to tell you that the best guarantee of keeping your own personal Independence is by hanging on to whatever booty you got. And with that profound piece of homespun, I'll make like a tree, and leave.
Have a great month!
