Monday, 26 June 2017

Preserving Some Gains

The markets both here in the UK and also in the US have reached all time highs in recent months. This is obviously good for small investors but we all know that markets do not rise in a straight line - the upswings are inevitably followed by the downturns. In broad terms, the markets have been on the up since the dramatic crash of 2008.

This has accelerated over the past year or so and the US market has risen 30% since the start of 2016. The CAPE ratio is now over 30, almost double its long term average. It has only been higher on two previous occasions - 1926 and 2000, just prior to the dot-com bubble and subsequent crash.
(click to enlarge)

With a few blips along the road, the bull market has marched onwards and upwards for the past 9 years. This situation gives rise to much media speculation as to where the markets are heading next. Some say the boom will continue - Prof. Robert Shiller suggests a 50% rise from here - and others are more cautious. Sebastian Lyon at Personal Assets said in his recent annual report "...the valuation of asset classes are more stretched than ever, particularly after the 'Brexit boom' in UK share prices, and it all feels very 'late cycle'..."

In the UK we also have the weak level of sterling post June 2016 which gave a boost to global investment priced in USD. The pound has recovered from a low point of ~$1.20 to currently $1.27 but it remains way below its longer term mean average of ~$1.60.

Cashing In Some Chips

Until the market surge in the second half on 2016, I was more or less fully invested however in recent months I have been gradually reducing my equity holding and moving more towards defensive investments such as Capital Gearing and also cash. It seems to me sensible to reduce risk as the markets get higher.

I'm not suggesting current levels represent the top of the market bull run as I know it is impossible for anyone to predict the top (...or bottom). However, at this point in the cycle, my preference is to hang on to the some of the capital gains accumulated since 2009 rather than stay fully invested in the hope of squeezing out even further gains.

The problem with holding cash however is obviously the ultra low interest rates on offer and also the possibility of missing out on further market gains. The markets may well be over valued but that could easily continue for another year or two.

There is also the question of when to re-enter the market when they do swing down.

In the past 6 months I have moved around 25% of my portfolio from equities to cash. Some more of my individual shares have been sold - IMI, Berkeley, Amec Foster for example. Also I have sold some of my investment trusts - Dunedin Income, Murray International and Invesco Income and I have top sliced others - Aberforth Smaller, Edinburgh, City of London and Finsbury Growth.

Mean reversion suggests the markets will fall at some point and sterling will recover back to its long term average of ~$1.60 but this is unlikely to happen in an orderly manner and the markets and exchange rate may well continue to move against the tide for some time.

Investing during the prolonged bull run of the past 7 years has provided me with above-average returns of ~10% p.a. The longer term average for a 60/40 asset allocation would be nearer to 6% and at some point the tide will turn and when it does I fully expect a period of below-average returns. The average however will be well above the meagre returns from cash over the past few years. It is just over 8 years since the Bank of England reduced rates to a 300 year low of 0.5% (and currently 0.25%) during which period savers have struggled to get more than 2% on their savings.

I am probably being overly cautious with my recent sales of equity holdings but it just feels right in the current climate.


  1. I have been toying with the same sentiment for a while now but don't want to be sat in cash for to long. Interesting times!

    1. I think this is part of the dilema GeordieBoy. It feels OK to lock in some of the gains but the returns on cash, assuming it is withdrawn, are very low and you don't know how long you have to wait for the downturn. I probably regard these unknown factors as the price to be paid for the above-average gains of recent years...a sort of insurance premium.

      I guess there are no perfect solutions when you feel the markets are over-valued. There are times when 'cash is king' even when it does not provide much return.