Aviva Investors’ Nick Samouilhan steers a course through troubled water:
Throughout the ninth and tenth centuries, Vikings rampaged along the UK and French coasts. This was despite the famous fog of the English Channel, which made pre-radar travel difficult at times.
How the Vikings managed to guide their way to this pillage, navigating through the fog, has only recently been confirmed. Although hard to believe, the legends are indeed true. The Vikings made use of a particular type of crystal to locate the moon, stars and the like, in order to guide their longboats through the fog in the right direction.
Through a Glass, Darkly
These crystals, called “Sun Stones”, channelled the light much like polarised sunglasses do, allowing the user to see where the (faint) light was coming from. When the crystal was pointed at the light source a faint light could be seen through the channels in the crystals. This allowed the Vikings to isolate where the sun was, regardless of how thick the fog was.
Moving from pillaging to investing; think of valuations as being the investor’s Sun Stone. When equities are very cheap or expensive, this helps us say something about future returns regardless of how tumultuous markets currently are. For example, if equities look very expensive, with a price multiple far above historical averages, chances are that their long-term return prospects are poor. The converse is true for very low valuations.
Turning now to bonds, we see that investor appetite and actions from policy makers have pushed the yields of government paper in the UK, US and Germany to historical lows. Standing here and looking ahead, yields are more likely to go up than down – making the long-term return outlook for these bonds negative in our view.
Focusing on the Long View
However, Sun Stones only pointed out the broad direction that you needed to sail in. They didn’t tell you about the reef just ahead, which might necessitate a brief period of sailing in the opposite direction to navigate the ‘short-term’ issue. And by the same token, while long-term returns for UK, US and German government bonds are likely to be negative, there could still be situations when we would hold them. Concerns over the health of the global economy may, for example, lead to us holding them to protect portfolios. In addition, the ‘normalisation’ of bond yields is a long-term process, and any bond sell-off may create a short-term trade opportunity.
This point is important, because solely focusing on the long-term direction while ignoring short-term issues may lead to unacceptable portfolio returns for clients. The efficacy of how Sun Stones detect a light source was proved after one was found in a sunken boat off the Irish coast. While valuations matter for long-term investing, the short term also matters.