By GRAHAM FROST 10/03/2006
Investor euphoria, as measured by appetite for risk, has hit a 20 year high according to the Credit Suisse First Boston Global Risk Appetite Index. This is a remarkable turnaround from an all-time low in late 2002, but perhaps no surprise following three years when just about every asset class has consistently risen.
| "FTSE All Share volatility is at its lowest point since 1997..." |
Stockmarket volatility has also fallen substantially over that period, further boosting investors’ willingness to take on risk. In fact over rolling three year periods FTSE All Share volatility is at its lowest point since 1997, as shown by the chart below.
The euphoria has seen more investors head back into the markets; IMA figures show net retail fund sales rose to £999m in January 2006 from £225m twelve months prior. While it is encouraging to see investors buy assets that offer better potential long term returns than cash, could it mean some become over-confident and start biting off more risk than they chew?
If so, this is a concern. Much of the recent boom in asset prices has been fuelled by liquidity, i.e. a mountain of cash being either spent or invested. Were this ‘earned’ liquidity, resulting from surplus income or savings, it might continue to prop up asset prices in future. However, in the US and UK liquidity expanded largely through debt creation, so should the debt bubble deflate asset prices will almost certainly suffer.
As highlighted in our recent ‘Repossessions on the rise’ article, a surge in property repossessions in the UK suggests that consumers are starting to drown in debt, potentially bringing the liquidity bubble a few steps closer to bursting. Barclaycard recently added to the gloom by announcing that it had set aside a record £1 billion to cover losses generated by customers unable or unwilling to repay their credit card debt.
| "We are also in the unusual position that most asset types have been correlated..." |
We are also in the unusual position that most asset types have been positively correlated over the last three years, i.e. they have all generally risen in value. I believe this is only a short term phenomenon, so it is important not to lose sight of the benefits of asset allocation. Spreading a portfolio across a wide range of assets should provide some protection against one or more of the popular asset classes taking a tumble in future.
In conclusion, if you are about to make a new investment, perhaps via an ISA, I urge you not to chase recent past performance and to keep asset allocation at the forefront of your mind. Existing clients can review the asset allocation breakdown of their Bestinvest portfolio by logging into the Client Centre.