Even the ‘soundest’ investments carry high risk

For those with money to invest, and there are still many of those out there in the Irish economy, these are interesting, uncertain times.

Over the past five years there has been a constant stream of negative economic news, both at home and abroad. For those investors who got caught up in and blinded by that negativity and adopted a totally risk-averse strategy, significant investment opportunities have been missed.

The biggest opportunity has clearly been missed on global equity markets. Most equity markets bottomed out in Mar 2009 and since then have made stellar gains. The US Dow Jones has climbed almost 143%; the UK FTSE 100 has gained almost 98%; the German Dax is up almost 319%; the Japanese Nikkei is up 123%; and even the Irish market, as depleted as it is, has gained almost 130%.

While these are relatively long-term gains, this year alone, the Dow Jones has added almost 18%; the Dax has put on 21%, and the Iseq has gained almost 30%.

These gains can be explained by factors that include a belief that global policymakers would eventually engineer a sustainable economic recovery; corporate profits have recovered strongly, not least because the corporate sector reacted aggressively to the economic meltdown and extracted significant costs; some risk averse investors who have been fearful of sovereign default and who lost confidence in the banking sector diversified into an asset class that would not generally be regarded as being at the lower end of the risk scale; and, of course, central banks have been pumping massive liquidity in to the system.

As we approach 2014, the big question is if the gains made can actually be maintained. There are obvious reasons to be cautious.

Much good news has already been built in to markets both in terms of economic growth and corporate earnings. The reality is that the global economy is not likely to blow the lights out next year and will continue to struggle to work through the legacy of 2007.

The biggest risk is that at some stage next year central banks may start to ease back on their provision of liquidity into the system. This will inevitably worry the markets. However, these reservations have been around over the past year and yet did not act as a deterrent to the market’s progress.

The momentum in equity markets is still pretty compelling, so there is a fair chance they could go further before the inevitable setback occurs. A factor that could support markets is of course the fact that bond yields are at historically low levels with the German 10-year bond yield at 1.7% and the US equivalent at 2.7%. Not a lot to go for there.

Domestically, the investment and savings options are also complicated. The Department of Finance is dipping into private-sector pension funds in a manner Ned Kelly would be proud of; the tax on savings has been taken to penal levels; and one would have concerns about the banks.

This week, the investment firm GoldCore published interesting research examining how the ‘bail in’ or burning of bank deposits in Cyprus this year was a Rubicon-crossing moment that fundamentally changed the investment and savings landscape. The authors correctly point out that a precedent has now been created and, in future bank crises, it looks inevitable that risk-averse depositors will be burnt or bailed-in again.

This means the basic tenet of trust involved in putting money on deposit in a bank has been broken, and all depositors, be they charities, businesses, or individuals would not appear wise to have more than €100,000 on deposit in a single bank.

In this nervous and uncertain world, even the very low return investment options have suddenly become risky.

GoldCore recommends the need for real diversity now more than ever. It is hard to argue with that.