Asset allocation is at least as important as individual share selection. So where should you be putting your money? Here’s May’s take on the major asset classes.
Bonds
Insanely expensive
Government paper has been extremely expensive for years; now it has become insanely expensive. Yields have gone negative in some cases, meaning that investors will make a loss if they hang on to maturity. The average yield on all German government debt is now zero. Investors are clearly hoping to sell these bonds, which are being hoovered up by the European Central Bank, on to another investor at an even higher price – the hallmark of a market bubble.
Corporate debt isn’t cheap either. Yields have slipped to the mid-single digits, the kind of level that in normal times would have been associated with solid government credit. Companies have continued to lock in cheap credit for the long term: in the first quarter, firms raised $79bn and $39bn in the US and Europe respectively, according to credit-ratings agency Moody’s. While a pin that could burst the bubble, such as a jump in inflation, is not currently in sight, we would steer clear of corporate bonds.
Property
Look abroad for bargains
The housing market has featured prominently in the UK general election campaign, with Ed Miliband’s proposed exemption from stamp duty for first-time buyers hitting the headlines this week (see page 5). Like the Coalition’s Help to Buy scheme, it would merely boost demand and prices in an already overpriced market. Price rises are already set to accelerate now that lenders appear to have digested the new mortgage regulations introduced last year. According to the British Bankers’ Association, mortgage approvals rose at the fastest pace for more than a year in March. Look outside the country for better bargains in residential property.
Equities
Follow the printed money
Among developed markets, the most appealing regions are those with a tailwind provided by central banks. In the US, the Federal Reserve is set to raise interest rates later this year, and stocks are also expensive (see page 6). But in Europe and Japan the European Central Bank and the Bank of Japan are busy printing money, which bodes well forstocks as the liquidity finds its way into asset markets. The Bank of Japan is soon likely to print more in order to get inflation up to its 2% target. Equities are still reasonably valued in both regions, and the earnings outlook has improved.
Emerging markets did better than developed ones in the first quarter, a rare example of outperformance in recent years. This was due to a strong showing from China, more stable commodity prices, and a sense that monetary tightening in the US is on hold. Go for countries with large domestic markets and governments working on their structural problems, such as India, Indonesia and the Philippines.
Energy
Oil rebound unlikely to last
Oil prices have bounced in the past few days, with Brent futures exceeding $60 a barrel. But it would be jumping the gun to bet on a strong recovery in prices. While oil may have bottomed, a return to $100 seems unlikely for now. The number of rigs at work in the US has fallen sharply, but so have the costs of fracking as technology improves; according to the IHS Cera consultancy, they are down by a third in just a year. So many wells will be able to keep producing despite lower prices. More Iranian oil could soon hitthe market again as sanctions are lifted. Russia has also managed to keep output above anticipated levels despite sanctions, notes Der Spiegel. So supply remains ample, while lower prices have yet to boost demand significantly.
Precious metals
Shelter from the storm
Keep 5%-10% of your portfolio in gold. Not only is it seen as a safe haven in troubled times – so shock waves after a potential Greek exit from the euro would give it a boost – but it is also insurance against an eventual surge in inflation after all the central-bank money printing of recent years. Emerging-market demand should gradually climb too as increasingly wealthy consumers seek gold jewellery or an inflation hedge; emerging-market central banks are also buying in order to diversify their foreign-exchange reserves. Silver is for gamblers only: while it tends to mimic gold’s movements, the small market makes it extremely volatile.
Commodities
Play the softs
Raw materials are treading water, and a sustained upswing isn’t likely yet. China, the key source of demand for metals, continues to slow. Large supply increases are still dampening some metals’ prices: the recent bounce in iron ore prices will dissipate, reckons Goldman Sachs, with prices likely to sink towards $40 a ton in the next 18 months. Agricultural commodities are in a structural bull market owing to the dwindling supply of arable land amid climate change and rising populations. Play the theme with fertiliser and farm-equipment stocks.