That dreaded word, volatility, has crept back into market commentary and investors are once again starting to think about how best to protect their portfolios should we see another sharp correction.
Equity market volatility has doubled in the past month, with several days of falls of more than 1 per cent in the past two weeks alone. Nervousness about economic growth, sparked by an unexpected decline in US retail sales and very poor industrial data out of Germany, has sent bond yields lower and prices higher as investors seek safe haven in lower risk bonds.
If you are an SMSF, how do you best insulate your portfolio in markets like this?
Chair of the US Federal Reserve, Janet Yellen stepped in tell markets to stay calm. That’s good advice. In Australia, a Reserve Bank Assistant Governor warned that we have become complacent about risk and that “exits tend to get jammed unexpectedly and rapidly”, meaning those attempting to pick the right time to exit can easily miss. More good advice – calmly head for the exits when you are ready, not after everyone else has.
The most interesting comments though came from Christine Lagarde of the International Monetary Fund. She calls the new world economy, post the financial crisis, “the new mediocre”. Growth won’t be high, but nor will it be very low. It will be mediocre.
For a start, if you hold enough diverse investments and don’t need to be a forced seller, you can simply hold onto your assets and wait for deposits and bonds to mature and the sharemarket to correct. Institutions sometimes have to be forced sellers, as do investors that use margin lending. But ordinary SMSF investors can outperform these investors by just staying calm.
Secondly, have a think about what “the new mediocre” means for your portfolio. Mediocre is not good for shares as they need earnings growth to perform, particularly low dividend shares. They will also be the most volatile when markets get nervous, as we’ve seen recently.
On the other hand, bonds like mediocre. Bonds like boring, low growth markets. The higher yielding Investment Grade corporate bonds’ returns over the past decade have been around the same as equities, regardless of whether that is in the equities boom years of 2004-2006 or 2011-2013, or the volatile years in between. Year in, year out, 5-8 per cent per annum income.
With the EU in the doldrums, China slowing but very gradually. Australia is trying to reinvent its economy after the mining boom and it is only the US that is performing. That’s the IMF’s outlook for much of the next decade – the new mediocre. Perfect conditions for corporate bonds.
