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A false sense of security?

” We need to be more aware than ever that asset values cannot go up forever “

As it is now ten years on since the collapse of Northern Rock and the visible start of the Global Financial Crisis it seems appropriate to step back and remember a few basic principles of investing that many appear to have forgotten, and that could have painful consequences.

Historically it has always been prudent to spread your investments and pension funds over a range of asset classes to help spread risk. The idea being that different asset classes such as Residential Property, Commercial Property, Equities, Commodities, Cash and Fixed interest securities such as Government Gilts and Corporate Bonds, will all behave differently at defined points in economic and market cycles, and that by spreading your risk you will not expose yourself to excessive losses if one or more asset classes has a significant or sudden drop in value.

This ‘diversification’ has served people well for generations, but was really tested in 2007/2008 when there was such a fear of meltdown following the major bank failures and many had borrowed against the value of their investments to buy yet more investments, that all asset classes were put under severe selling pressure that dragged them all down at the same time. Whilst the global financial system is not truly fixed following the crisis, it is certainly in a better place now, helped significantly by Government printing money (Quantitative Easing) to inject cash into the financial system and real economy.

But, whilst QE has undoubtedly in our view, saved the world from total meltdown, it has created a completely unnatural and previously unseen environment, and this may well cause more surprises further down the line. One of the intended consequences of printing money is to create more cash in the economy, and by buying back their own debt and re issuing it at lower interest rates, Central Banks will have structurally lowered interest rates to the lowest they have ever been, and will remain low by historical standards for years to come. It is this that has created the significant price inflation we have seen in Property, Equities, Government and Corporate Bonds, and outside of the conventional investment world, mad increases in Classic Car values, Antique Watches, Art etc as investors have seen no or negative real returns for their cash in the bank and have put their money elsewhere.

So prices of most assets types have reached all-time highs, and the income or yield that they deliver has been dragged down as a consequence, which in turn has led investors to buy anything with a yield that is above cash interest rates, which in turn pushes their prices up even higher. Some ‘High Income’ stocks and for example are now anything but and have prices that cannot justify any further increases.

Whilst it took the European Central Bank 6 years to persuade Germany to undergo any significant Quantitative Easing, and their programme is still on going as they play catch up, the QE process has slowed in the USA and the UK, (albeit with a relaxation following Brexit when we reduced interest rates by a further 0.25% and the Bank of England started buying corporate bonds). It is likely therefore that as the major central banks begin to withdraw or slow down their QE programmes interest rates will rise slowly and the mad price inflation in many assets will surely slow, or even reverse.

Although the collapse of the pound following Brexit and a surprising level of euphoria over Trump’s election led to a Stock market rally this appears to be fizzling out now, and there is plenty of evidence showing that the growth in property prices, especially residential has slowed, and in some areas prices have begun to fall. IF QE is withdrawn too quickly, and it is going to be a very difficult balancing act for central banks, we could see a rapid loss of investor confidence, which if has happened in the UK, coincides with significant political or policy changes, (Brexit and investment property tax rises) will lead to falling asset prices.

So, as easy as it is to look back at the ten years since the crisis and feel that asset price inflation has helped our recovery, we need to be more aware than ever that asset values cannot go up for ever, and it is more important than ever to hold a diversified investment portfolio. We have certainly seen too many people holding too much in Property and High Income Equities, which could prove fragile over the coming year or two.

Before making any purchases, we recommended you discuss any questions you have with your professional adviser.

Martin Lamb[email protected]