Markets on a high covers over cracks - tactical portfolio Mar 15 update

The FTSE 100 hit a new all-time high of 6974 at the start of March, some 15 years and two brutal bear markets after it last reached this level in the dotcom bubble. While this is exciting, it also indicates the market may be due a pause.

The FTSE 100 is home to the bloated and weary, and disappointing earnings figures from the likes of Barclays and HSBC in the banking sector, big pharma such as AstraZeneca, and major oil stocks and miners are disconcerting. Admittedly, the oil majors are receiving a boost from refiners benefiting from lower costs for crude, but this is likely to be short-lived.

The answer is not necessarily to move down the market capitalisation scale in the hope of finding better value. The FTSE 250 mid-cap index has itself risen by a remarkable 307 per cent in the last 15 years (with dividends reinvested). Over the same period the FTSE 100 has gained just 90 per cent.

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There are similar arguments in emerging markets, where earnings expectations have come down considerably. 10 per cent is now the consensus this year for large caps - double that for small caps. However, here again, enthusiasm may be overreaching itself.

In India, forecasts on earnings growth have risen since prime minister Narendra Modi gained control, although they had already pre-empted the election result, but earnings in the last quarter were actually the worst for the past six quarters.

The problem with zero interest rates globally is that they have pushed the valuations of most assets to historically high levels, forcing investors to downplay risks.

This must surely begin to reverse when quantitative easing (QE) becomes quantitative tightening. Last year was full of unexpected reversals, and nothing has happened to stabilise the market and change that.

Russia could be one bright spot, as it is that rarity, a market that has been oversold. Russia is trading on a price/earnings (p/e) ratio of 3.8 times and a book price of 0.47 times, compared with emerging markets as a whole, which are trading on an average p/e of 11 times and a book price of 1.4 times.

Historically, emerging markets have almost always bounced back after geopolitical crises such as the Yom Kippur war, the Iran/Iraq crisis, the invasion of Afghanistan and various Cold War incidents.


So this month we are going to top-slice a portion of our holding in iShares FTSE UK Dividend Plus and add to our holding in the Russian equity ETF - dbx MSCI Russia 25% Capd - figuring that as mourners take to the streets of Moscow for the funeral of opposition politician Boris Nemtsov, it will be well ahead of any real recovery in the market.

China is also relatively cheap, on a p/e of 9.6 times, but in the short term it has banking issues and its non-performing loans are certain to rise.

Concern that markets are on the whole overpriced is clearly shared by the gold bugs. BullionVault reports that investor sentiment for gold has jumped to its strongest level since spring 2013. And it reports a similar story for silver. Gold speculators are concerned about the direction of central bank monetary policy and are buying on price weakness.

Our portfolio is light on bonds, but it is hard to whip up excitement at a time when bonds offer some of the lowest returns in history. Bond buyers tend to be the banks, which are forced to hold bonds by regulatory pressures, and asset managers that have hitched their wagons to the principles of true diversification.

For the time being, the aggressive bond purchase programmes of the European Central Bank and the Bank of Japan have pushed bond buyers into US Treasuries and UK gilts, which therefore remain well-supported despite the fact that the zero interest rate policies of the Bank of England and the US Federal Reserve are about to change.

However, QE, low inflation and high geopolitical tensions will not last forever, and both gilts and corporate bonds are likely to do badly in the next decade.

The other difficulty with bonds is that most investors have to use a fund and are lumped into indecipherable bond funds where returns are hard to predict.

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