Paul Killik
Partner, Senior Executive Officer

As global markets continue to test new highs, investors may be asking themselves whether they should take some money off the table. However, I would argue that such a binary question, about whether an investor should be “in” or “out” of equities, is the wrong one.

 

A much better question, that anyone with long-term, or “lifetime” savings, as I prefer to call them, should constantly ask themselves, is whether they hold enough cash to meet emergencies and to fund near-term and foreseeable cash requirements. This can be judged according to where you see the market in the context of its longer-term cycles. Once you have sufficient near-term cash, then apart from looking for opportunities to rotate from expensive to less expensive parts of the equity market, I would advise remaining fairly fully invested.

"A much better question, that anyone with long-term, or “lifetime” savings,[...] is whether they hold enough cash to meet emergencies and to fund near-term and foreseeable cash requirements"

The main reason is the difficulty of second-guessing the market twice – once, when you come out and when you decide to get back in again. All too often, I have seen clients pat themselves on the back for taking money out of the market before a fall, or on the way down, only to miss the opportunity to buy back in before the market recovers to the point at which they exited.

A quick look back

The bear market triggered by the financial crisis 10 years ago was an interesting example, and one of only three such serious bear markets that I have experienced in 50 years in this profession. The FTSE topped out in October 2007 and then started a gentle decline. As events worsened throughout 2008, the descent grew steeper. With the benefit of a rear-view mirror, we can see now that the banking crisis more or less peaked with the failure of Lehman Bros in Autumn 2008. Nonetheless, the stock market, ever fearful of more calamities, continued dropping until early March 2009. By then it had nearly halved from its value only 16 months earlier.

However, at that point the braver buyers started to outnumber exhausted sellers and by the close of that year the stock market had recovered to around only 20% below its October 2007 level. Fast-forward and it has climbed, at the time of writing, to around 20% above its peak before the crash.

"Uncomfortable as it was, you could have ridden out the entire cycle without selling."

My point? Your chances of timing this cycle were slim. Besides, provided you had enough cash, or near-cash (such as short-duration fixed income securities) available to meet your immediate needs, you wouldn’t have had to. Uncomfortable as it was, you could have ridden out the entire cycle without selling.

As for how much cash you hold, that goes to the heart of your investing personality – cautious investors will always hold more than their adventurous peers. That’s why this is something you should discuss with your Investment Manager.

Our Income Monitor revisited

Some investors will nonetheless worry that a falling market may never recover. Here, I would like to revisit our Income Monitor (see below). As some of you will already know, the starting point is the turn of the millennium, when the market was at the top of a long-term bull market, that some might argue started in 1975.

Over the last 17 years we have seen two big bear markets, the first 2000-2003 and the second I referred to earlier. These represented two of the three worst bear markets of the last 50 years and yet the aggregate income produced by the firms within the FTSE All Share Index has more than doubled over that time. Interestingly, the first bear market hardly registered on the Income Monitor, whereas the second was more pronounced. This was not surprising given that the financial sector, and particularly banks, suffered big dividend cuts

Further, we can make sensible inferences from the yield on the wider market for a steer on its valuation since high dividend yields have tended, historically, to point to share price growth. Here, the equity market scores well, even after dividend progress that has been little short of remarkable, given the turbulence in capital values over our review period.

How it works

Our starting point is the FTSE All-Share index, from which we calculate the annual income produced by its constituents by according a value of £1 to each unit in the index. At 31st December 1999, this stood at 3246.06, which gives us a starting value of £3,246.06. The dividend yield then was 2.12%, giving us a starting income from the index of £68.73 (2.12% x £3,242.06).

In the 17 years to 12th December 2017 the index had risen 26%, growing in value to £4,101. However, we can see that the nominal income generated has risen by 120% to £150.

That represents a current yield of 3.66%. What is more, as the FT noted recently, UK dividends grew faster in the third quarter of 2017 than in any other global region. That provides another strong underpin to equities.