Kate Rogers: The picture is dull now - but fortune may favour the brave

Economic recovery is meeting expectations; however, there is a lot going on under the surface, writes our columnist

Kate Rogers
Kate Rogers

Summer may have brought us excitement in sport and in unpredictable weather, but the same can't be said of investment markets, which have been unusually dull and trendless.

Measures of risk have been falling and volatility in markets is low – surprising, given the tensions in Ukraine and Gaza. Why is this? After such dramatic upward movements in equity markets last year, a lot of the economic recovery story is in the price. It is a characteristic of equity markets that they move on expectations; statistics tell us that markets react nine months to a year before the news is reflected in company earnings. It is not whether economies and companies are doing well that moves markets; it is if they are doing better than expected. At the moment, the recovery is meeting expectations. Accordingly, a broad range of assets have delivered positive, but boring, returns in 2014.

However, like the serene swan drifting about on the pond, there is a lot going on beneath the surface. Merger and acquisition activity has picked up considerably, showing that businesses have both cash and confidence. Conversely, mid-sized companies have started to perform less well than their larger counterparts – a sign often associated with later-stage bull markets.

Having had a five-year blinder of strong performance relative to the market, active fund managers have struggled to keep pace, with second-quarter results showing the average UK fund manager delivering a negative return against the market's positive return. I suspect your own charity investment portfolio will show the same characteristics: decent, if dull, performance, with managers finding it difficult to match the market in recent months.

Equity markets have also been supported by a financial version of the ugly bug ball. When you're getting virtually no interest on cash, and bonds have high prices and low income yields, investors understandably look to equities as the least bad option. At least equities offer a decent income yield, which is important for many charities. But are we setting ourselves up for a fall? As markets have moved up, so too have valuations, and it is now a challenge to find cheap assets. UK equity markets are about long-term average value (using price-to-earnings ratio as a measure of how cheap or expensive markets are) and the US looks expensive. This isn't necessarily wrong if companies are doing better than average, but perhaps a bit of caution and some profit-taking around the edges might be prudent.

It seems that value might lie in the emerging markets, where slowing growth has worried investors over the past two years. The tide might be changing for some of these, and emerging market equities have bounced back since March. These will be volatile and are risky; but perhaps fortune will favour the brave.

Kate Rogers is client director at Cazenove Charities

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