Cash, gilts and long-dated bonds. Three of the most defensive and (to some) boring parts of the market. Yet they are in vogue.
This week interactive investor statistics revealed that a money market fund was the most bought across its platform last month. Meanwhile, in September investors were allocating to gilts, according to the latest figures from the Investment Association.
There are clear reasons for this. Earlier this week both the Federal Reserve and Bank of England continued their pause on the interest rate hiking cycle to give their moves made over the past 18 months or so a chance to come to fruition.
They have been upping rates to stymy inflation in their respective countries – which in both cases remains nowhere near the 2% target both strive for.
The aggressive monetary policy moves however take time to work their way through the system and can require as long as six months before the full effect is felt.
As a result of the latest slowdown, some are already prognosticating that we are now at the end of the cycle, with rates only likely to go one way from here – lower.
In theory, it makes now a great time to pile into higher yielding defensive assets such as cash and government bonds, which will increase in price when interest rates start to drop back down.
Equity income funds could also prove popular, as investors covet the dividends paid by dependable companies rather than chasing growth.
Yet falling interest rates should also benefit growth stocks, which tend to be valued on the expected earnings some way off in the future. Any reduction of the interest rate – the yardstick against which this growth is measured – would surely be a positive.
All this implies that we are heading into a golden era. If the theory is correct, then investors would struggle not to make money.
But I’m not so sure. In fact, I look around the market today with bemusement. Tech has risen despite rising rates – thanks in part to the boom in artificial intelligence (AI).
Value stocks have been fine, but hardly spectacular, with banks remaining unloved – possibly due to investors still suffering the burned hands from the financial crisis of 2008.
Bonds have been hammered but offer good yields. Investors could sit on them and cash in the coupon, but many are still less than inflation, meaning they are losing money in real terms.
The only place that has truly taken a hit is smaller companies, which have been shunned by investors who can either get higher yields from taking far less risk, or are benefiting from the huge rally in large-cap tech names.
But anything could happen. In six months’ time, rates could be on the rise again if inflation is not deterred, or they could be cut to stimulate economic growth.
The exuberance of AI could prove to be the next coming of a technological revolution, or another 2000-style tech bubble waiting to burst – I have heard arguments for both in recent weeks.
Small-caps could rebound, or remain in the doldrums, while bonds may reprice and net nice capital gains, or remain yielding less than inflation.
All of this leaves me scratching my head. It seems the future is unclear and there is no way of knowing without a time machine. Seemingly you can make a case for anything to happen and could make moves accordingly. If you’re right the pay-off could be huge, but it could equally backfire. As such, I do not believe now is the time to make changes – even though I understand it is extremely tempting.