Weekend reading: My meaningless thoughts on the market

Some musings on the investing landscape, followed by the weekly links.

Those who tout connections between the past performance of the stock market and the date on the calendar will be excited as 2010 closes.

Already we’re promised a ‘Santa Rally’ – the historical data suggests shares go up much more than down in December. The first months of a new year are invariably touted as good ones, too, before we’re told to ‘sell in May and go away’.

There may be some truths here, for all the silliness. It’s argued small cap shares do well in January, for instance, because US investors have begun a new tax year, and so feel more confident about taking risks.

But overall the human calendar is an artificial one when imposed on top of the business and investor sentiment cycle.

Think of the key periods over the past couple of years:

• The six-months of fear and loathing from the collapse of Lehman Brothers in September 2008 to the start of QE in March 2009.
• The ‘dash to trash’ rally from April 2009 to April 2010.
• The on/off sovereign bond wobble of late Spring until November.
• The ‘risk back on’ mood of the past few weeks.

None of these moves had the decency to fit to any calendar schedule. Instead, newsflow, emotion, and the underlying business cycle combined to drive valuations.

My meaningless thoughts on the market

So what sort of phase are we in now? For what it’s worth (nobody knows where we’ll go!) I’m still happy being very long shares in this climate, particularly as government bonds look so expensive.

True, with stock market writers now making a case for the FTSE rallying to 8,000, it’s hard not to suspect people are getting greedy.

But company earnings are growing strongly, balance sheets in good nick, and plenty of money still sits on the sidelines. With a P/E of 11, the UK stock market does not look expensive, and a much higher level for the index in the next 24 months doesn’t look overly fanciful.

Long-time readers may recall I suspect we’re into a new bull market, although the dramatic rise in the stock market since I wrote that in 2009 does curb what we can realistically expect from here.

Inflation is the outcome

The underlying fundamentals are changing, too. US government bonds are selling off, and here in the UK the yield on the 10-year gilt is back above 3.5%, which is higher than the yield on the All-Share – a normal state of affairs, but not something we’ve seen for a while.

Inflation expectations are rising, too. UK inflation has been ahead of target for months, despite relatively high unemployment, but it’s the emerging markets that we need to watch: At 5.1%, Chinese inflation is running at a 28-month high.

Inflation might eventually curb the appetite for emerging markets, if rates are lifted to dampen down growth. But emerging market investors should expect volatility at all times, anyway, and have a long-term strategy to invest through it, such as monthly investing into a suitable fund.

With inflation looking far more likely than deflation to me, I remain happy being very overweight UK equities. I’d probably buy more European shares, if the Euro wasn’t so strong. Ditto the US, where I’d be most likely to invest in technology stocks. A strengthening pound in 2011 would be a nice opportunity to add to overseas holdings.

I have been fiddling a bit with what I buy, in the UK, though.1

Income investment trusts are looking relatively expensive, for instance. I was buying these on fairly decent discounts to their Net Assets, but now some are trading at a premium. As a result I’ve already sold one big holding, and moved the money into a giant UK growth trust, which was trading at a nice discount. Others may follow.

The reason income trusts are trading at a premium – in contrast to the big discounts of two years ago – is that retail investors have grown less fearful and so will buy shares, but they really want income. As a result, the relative valuation between growth and income shares has been compressed. But it won’t stay this way forever.

If you’re a long-term investor in income trusts for the regular payouts, you can ignore all this. Just be aware that you can’t expect to always get the higher starting yield AND superior capital growth like we’ve enjoyed recently.

No free lunches!

More from the money blogs

• Why index investing doesn’t cut it for me – Simple Living in Suffolk
• Why are annuity payouts higher than bond rates? – Oblivious Investor
• Even star bond managers think equities are cheap – Investing Caffeine
• The trouble with a high dividend stock strategy – Moneywatch
• Gold price rise in British pounds – Retirement Investing Today
• In defence of chartists – The Psy-Fi blog
• My shift to buying earnings – UK Value Investor
• Review: The Warren Buffetts Next Door – iii blog

On the Money Mavens network

• Canadian Finance blog knows some money saving tips.
• MH4C has worked out the cost of delivering a baby.
• Len Penzo looks at US mortgage junk fees.
• TMW has some Christmas gift ideas for military members.
• Wealth Pilgrims offers US readers a few financial tax planning tips.
• Joe Taxpayer tells US readers about a new little tax deduction.

From the mainstream financial media sites

• Big pension rule changes on the way – Motley Fool
• RBS to offer house price derivatives – FT
• Euro woes still boosting London property – FT
• How much does a university education cost? – Telegraph
• Stiglitz: QE2 poses considerable risk – Telegraph
• High hopes of a new climate change deal – Telegraph
• Boom time for investors in Germany – The Independent
• Making the case for VCTs – The Independent
• The secret to resigning gracefully – The Guardian
• How to avoid being a Ponzi scheme victim – New York Times

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1. Remember, as ever I recommend most investors are better off concentrating on asset allocation and passive rebalancing. I’m just a fool who should know better! [↩]