As we approach the half-year mark, I’ve been reflecting on what the past six months have brought investors.
Look at the start and end points for many of the key indices and you’d think not much has happened. It’s been eerily quiet as markets have scaled the wall of worry.
But behind the scenes there’s been plenty to think about. Here are five things I’ve learned.
Too cute
First, related to that calm, it’s clear that you can sometimes be too cute about your investments.
The absence of volatility in markets has caused many to worry that investors are not worrying enough. It all feels a bit too much like the calms before the storm in the late 1990s and again in 2007. But these periods of low volatility can go on for extended periods.
The cost of insuring against market swings – the so-called Vix index, also known as Wall Street’s “fear gauge” – is low but it stayed at such levels for much longer in the Clinton years and again between the dot.com bust and the financial crisis.
Complacency
Second, low volatility can breed complacency and recent months have shown the early signs of excess creeping into financial markets.
Examples of warning lights flashing amber include: the IPO market where the quality of companies choosing to float is deteriorating; commercial property, where the chase for yield has taken investors as far as Spain, where they are happily ignoring the deflationary threat and still high unemployment; and the bond market, where that alphabet soup of derivatives is making a comeback – CDO squared anyone? But the lesson for me is that worrying too soon about excess is a recipe for expensive inactivity.
This feels like 1996 in the equity market and 2005 in bonds and property. It’s too soon to take money off the table.
Not always right
Third, what seems obvious is not always right.
The over-valuation of the bond market seemed self-evident at the start of the year but fixed income has been the place to be in the first six months of 2014. Bonds have defied the sceptics because: the demand for safe income has not gone away; new equity highs have persuaded some investors to cash in and match their liabilities with more predictable investments; inflation has remained subdued; and, simply, in a low interest-rate world, the attraction of a reliable 3 per cent income from US Treasuries has put a lid on bond yields.
Unpredictable
Fourth, events are unpredictable.
Nowhere has this been clearer than in the commodities markets. Agricultural resources soared and then slumped – blame the weather. Gold slid and then recovered – point the finger at the Federal Reserve. Metals moved sideways – that’s largely the fault of the Chinese.And oil was spookily calm until out of the blue the Syrian catastrophe crossed the border into Iraq.
If anything could derail the recovery, it is a 2008-style spike in energy costs but, until a couple of weeks ago, this was on no-one’s radar.
Hope springs eternal
Fifth and finally, hope springs eternal.
The enthusiasm of foreign and domestic investors for Narendra Modi’s BJP party was evident as soon as it looked likely that they would put an end to Congress rule in India. The lesson from the surging Sensex is that it is often better to travel than to arrive in investment.
The Indian stock market has risen by around 60% between the beginning of 2012 and the mid-point of 2014. At some point, investors will question how well the challenge of transforming a huge and diverse country is priced in.
There’s always something to learn from Mr Market. But the past six months have been particularly instructive.
