Veteran UK investor Jim Slater is known for his penchant for high-flying growth shares. But that doesn’t mean he’s always optimistic.

Slater has lived through many market cycles in his five decades of investing, and like any great investor he knows that shares go down as well as up.

Back in 2008 I found his signs of a bear market bottom a useful waypoint in navigating the slump.

But Slater has also shared some tips on how to spot a bull market top.

Predicting the next move in the stock market is notoriously difficult, if not impossible. (Remember the Vanguard study that showed that pretty much all methods of forecasting market returns were useless?)

And calling an end to a bull market is even more dangerous than doing the same for bear markets.

With a few notable exceptions1, stock markets have always bounced back from big corrections.

You might have to wait for a few years for your guess that a bear market will come to an end to prove right – perhaps long enough for you to have really got the call wrong – but all bear markets ended eventually.

The opposite is not true of bull markets.

Despite what some cynics seem to think, markets are cyclical over the short run, but in the long run they tend to rise higher. The UK and US markets stand far, far above their levels of 30 to 100 years ago.

If you predict a market is due to pause or fall – which is what calling the top of a bull market amounts to – then you are betting against this trend.

So timing is all-important.

Signs of a bull market top

Most of us will do better not to try, but for those who want to have a stab at stock market prognostication, here are Jim Slater’s signs of the top of a bull market.

(Note: My comments are in italics).

Cash is trash

The ‘rubbishing’ of cash and the consequent low institutional holdings are an obvious danger, signalling that most funds will be fully invested. Does this hold after a period of 300-year lows for interest rates? I’d bet not, but Japan’s experience says otherwise.

Value is hard to find

The average P/E ratio of the market as a whole will be near to historically high levels. The average dividend yield will be low and shares will be standing at a high premium to book value. Some people would prefer to look at the cyclically-adjusted P/E ratio here, though I’d be cautious.

Interest rates

Interest rates are usually about to rise or have started to do so. In mid-1995, interest rates in both the USA and UK had been rising from historically low levels. Investors were wondering how much further they would rise before topping out. (Since Slater wrote these words, we’ve seen what historically low interest rates really look like…)

Money supply

Broad money supply tends to be contracting at the turn of bull markets.

Investment advisers

The consensus view of investment advisers will be bullish.

Reaction to news

An early sign of a bull market topping out is the failure of shares to respond to good news. The directors of a company might report excellent results only to see the price of their shares fall. The market is becoming exhausted, good news is already discounted, and there’s very little buying power left.

New issues

Offers for sale, rights issues, and new issues are usually in abundance, with quality beginning to suffer and low-grade issues being chased to ridiculous levels.

Media comment

The press and TV tend to give more prominence to the stock market and to be optimistic near the top. If prices appear high in relation to value, the argument is that ‘it will be different this time’. The few bearish articles that warn of dangers to come are ignored by investors.

Party talk

At the peak of a bull market, shares tend to be the main topic of conversation at cocktail and dinner parties. The financial crisis has made the market a talking point for years, however, so perhaps this indicator is misleading in the current environment?

Changes in market leadership

A major change in leadership is often a prelude to a change in market direction. Near the top of a bull market, investors often move from safe growth stocks into cyclicals, which they buy heavily.

Unemployment

An interest study by Matheson Securities of ten stock market turning points demonstrated the stock market turned downwards on average about ten months after the unemployment figures began to fall. Remember that unemployment is a lagging indicator.

Want to learn more from Jim Slater? Check out his superb guide for small cap stock pickers, The Zulu Principle.

1. China and Russia especially, but arguably also Germany and Austria. [↩]

The best plan I’ve seen yet for securing your retirement income is to create a minimum income floor. This entails investing your pensionable assets in the safest financial products that can cover your basic needs for the rest of your life.

Anything left over is tucked away into your emergency fund and a ‘risk portfolio’ that’s tapped when you want to pay for life’s little luxuries.

It’s the retirement equivalent of hitting the casino with your play money in your top pocket but keeping your bus money strapped to your leg.

Floor in the plan

So how do you go about constructing a minimum income floor?

Firstly, the point of a floor is that you can’t fall through it. In other words, if you need £12,000 a year then your floor should always stand you that amount until you pop your clogs.

Secondly, the floor must be protected against financial dry rot:

• Inflation – This money-eating fungus can halve the value of your cash in a little over 20 years at the inoffensive rate of 3%, or in three years at a galloping 20%. And £12,000 per year is no good when it only buys you £6,000 worth of retirement. This is why most retirees don’t have the luxury of staying in the safest asset class of all: cash.

• Bad market returns – A portfolio of equities and bonds is too risky for a minimum income floor. There’s no way to be sure that a gruesome bear market won’t chew up your wealth and leave you unable to sustain your lifestyle.

• Bankruptcy – Banks, insurance companies, annuity providers and fund managers can all go bust. Retirement income products may need to last 30 years or more, so as ever it’s important you don’t place every egg in one smash-able basket.

Planks for the memories

So which financial products can form the planks of your income floor?

William Bernstein, investment advisor and scourge of Wall St, has narrowed the options down to three in his riveting book, The Ages of the Investor.

Option 1: Boost the portion of your floor covered by the State Pension

The State Pension is the best annuity around: an inflation-linked, government-backed income stream that will flow for the rest of your life. Money doesn’t get any safer than that.

You can boost your UK State Pension by deferring your claim. Every year of deferral increases your income by 10.4%. It can take a decade to recoup the cash forgone but it’s a good hedge against a long life.

Option 2: Build a ladder of index-linked government bonds

Again you’re inflation-proofed and putting your faith in virtually risk-free assets.

The key to not losing money on the deal is to buy individual index-linked bonds directly from the Government and hold them to maturity. As opposed to buying bonds in the secondary market or in bond funds.

As each bond matures it pays a portion of your income. All will be well provided you don’t live longer than the top rung of your ladder.

That whopping great snag aside – this option is now feasible since index-linked gilt yields have rebounded.

We’ve written a comprehensive guide on how to build your own index-linked gilt ladder. 

Option 3: Invest in a conventional, index-linked annuity

Inflation-protection? Check. Income guaranteed for the rest of your days? Check.

Risk-free? Nope. The annuity provider could go belly up, although there’s no modern precedent for this in the UK.

If the worst does happen then the Financial Services Compensation Scheme (FSCS) would cover you for 90% of the annuity. Ideally, you’d have a couple of annuities from different providers to prevent your income being totally disrupted by delays or even the complete malfunction of the FSCS scheme.

Nailing it

None of the options are perfect. The State Pension is too small, the linkers scant in supply and returns, and the annuity is only as good as the credit risk of an insurance company.

In my case, I’m currently helping a close relative secure her minimum income floor, and I think the best way to do that is by combining the State Pension with a conventional, index-linked annuity.

Here are the important numbers:

• £12,000 – my relative’s required minimum income floor (after tax).
• £10,000 – the tax-free personal allowance 2014-15.
• £12,500 – the gross income my strategy needs to deliver to account for tax.
• £3,500 – the amount of State Pension my relative receives.
• £9,000 – the income required from the index-linked annuity.

Happily my relative’s situation is relatively simple. There are no dependents to increase the cost of the annuity and niceties like leaving a legacy can be jettisoned in the face of nailing down her retirement income.

Yes, she has to cede control over the majority of her pension pot but I believe it’s worth it to ensure she’s as secure as possible from here on in.

Critically, there’s enough left over to form an emergency fund and to invest a small portion for future desires.

A level annuity would provide a much bigger income today and the greed demons kept whispering in my ear: “It’ll be fine, inflation will stay low, take the big bucks now.” I’ll explore how close a call this is in a future article.

But my job is to take as much risk off the table as possible, including the risk of the inflation genie escaping his bottle and going on the rampage.

That thought is enough to make me recommend the pure version of the minimum retirement income strategy. With the floor nailed down and inflation-proofed, it should endure through most of the disaster scenarios a retiree is liable to face.

Take it steady,

The Accumulator

Good reads from around the Web.

Inequality is a rising – and a very real – problem. So it’s no surprise that those members of the chattering classes still able to earn a living coining bon mots for the broadsheets have come up with a new one: Wage rage.

Wage rage is what happens when your salary doesn’t go up in real terms, yet living costs and company profits do.

At the moment it’s mainly manifested in localised rants between couples in the grocery aisles of Tesco – one wants the asparagus while the other says make do with carrots – but it can only be a matter of time before the squeezed middle-classes angrily demand to see each others’ pay slips.

The lefty economist Chris Dillow, who writes curiously enough for the Investor’s Chronicle, has a Marxist explanation for why real wages have been falling:

…socio-technical change since the 80s such as CCTV, containerization and computerized stock control has made it easier for bosses to monitor workers. Direct oversight means they don’t need to worry about buying workers’ goodwill. They are instead using the Charles Colson strategy: “When you’ve got ’em by the balls, their hearts and minds will follow.”

Years ago, firms wanted smaller but motivated workforces.

Now they can control workers directly, they don’t need to worry so much about motivation and so are content with larger but grumpy workers.

Dillow argues that high-flying executives can’t yet be motivated by the threat of being replaced by someone in China or Amazon’s mechanical Turk, and so they have been able to increase their wages.

Is he right? I have no idea.

As an investor and a capitalist, I do wince though when I see company profits rising relentlessly even as revenues and real wages fall. That the richest 1% have got inexorably richer is just the icing on the cake.

The problem for me is not just that it’s arguably morally wrong for a few to benefit at the expense of the many – morals are pretty fluid, after all – but that it’s unsustainable.

Companies need customers. And democracies need some notion of equality.

Still, it only takes a few lines in The Guardian for my inner Thatcherite to come out swinging his man bag:

There are also signs that workers are paying a price for the new competition from the likes of lone parents, whom aggressive workfare policies are chivvying to take up whatever work might be available, irrespective of the wage.

Yes, there are signs of that in the same way that there are signs in tea leaves.

Inequality has been growing for decades, through various political administrations. It’s more likely down to technology, globalisation, and the near-universal acceptance of market economies. It’s not down to saying that people who can earn money should do so before dipping into the pockets of others.

And then there’s the language. Someone with a job is a “worker” but a parent with a child who gets a job is apparently still a “lone parent”.

When does a lone parent become a worker? And what do we call a lone parent who already has a job? Or shouldn’t they exist in Guardian-land?

Capitalism rules, okay?

My hope is that the slide in real wages is a symptom of the long economic slump and the lack of animal spirits.

Once the economy starts ticking up on a global scale, company bosses may well fall over themselves to employ more people to meet the demand, increasing the competition for workers (and those wage-less lone parents…) and putting more money in our pockets to spend. Gradually workers will claw back some of what they’ve lost.

A rosy outlook? Certainly, but it’s worked before.

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