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Is it time to ditch bonds for equities?

Tahmina Mannan
Written By:
Tahmina Mannan

The decision to switch back into equities is not an easy one, even for the most seasoned investor. Is now the moment?

One of the big questions for investors this year is whether or not to invest in equities.

A last minute agreement in Washington by policymakers made the start of 2013 a lot less eventful than expected, as the US managed to avoid the much feared fiscal cliff and the world – and markets – breathed a collective sigh of relief.

Although the problem is far from over, UK investors can relax somewhat in the knowledge that policymakers took action when it mattered most.

On top of this, there are some signs of improvement in the eurozone and US economy, although neither are out of the woods yet.

Looking at what’s in store for equities in 2013, investors can make both a bull and bear case for the coming year.

The UK economy is still struggling, with talk of a triple dip recession continuing. There are muted signs of growth and low interest rates – something that many expect to persist for some time.

Investors are likely to remain nervous as prospects for the UK equity market remain unclear. However, despite talk of bonds being the go-to for those refusing to sit on their cash, appetite for equities is showing signs of life.

Faced with similar conditions a year ago, equity funds have on average beaten the market. Do investors have enough reason to believe there will be a similar outcome in 2013?

Markets were unsteady for the first half of 2012, but more than made up for it towards the end of the year with the FTSE up roughly 10% between late May and early December.

Certainly the economic landscape is not supportive for markets. The Office for Budget Responsibility has predicted GDP growth of just 1.2% for 2013.

Despite Greece no longer being the biggest worry stemming from Europe, issues in the eurozone are unlikely to be resolved any time soon, and are dragging down France and Germany – southern Europe’s biggest trading partners.

However, a recent report from the Investment Management Association (IMA) shows that equity funds were strong favourites for retail investors over the three months leading up to November.

Daniel Godfrey, chief executive of the IMA, says: “Net retail sales were strong again in November with equity funds the strongest sellers for the third month in a row. This is partly due to investors preferring equity income over fixed income for income generation.

“With record funds under management, the funds industry is now managing funds worth over 50% more than in August 2008 just before Lehman’s collapse and the full onset of the global financial crisis.”

According to Barclays Stockbrokers, investors are optimistic. A poll by the broker found that investors predict the FTSE 100 Index to close high on the last day of 2013.

62% believe the FTSE will finish higher than it did at the end of 2012 – almost half said they think it will close between 6,001 and 6,500 and one in seven believes the index will close above 6,500 at the end of the year.

Paul Inkster, head of product at Barclays Stockbrokers, says: “Clients appear to be backing the financial sector as the one that will offer the best investment opportunities in 2013.”

Market analysts say equities are cheap for the most part, but the bond markets are tellingly overpriced due to investors turning to bonds in 2012. However sentiment is slowly changing as equities are predicted to yield higher returns.

Stuart Welch, CEO at TD Direct Investing, points to UK investors turning to opportunities close to home as a positive indicator for the year ahead:

“After suffering a shrinking economy since 2008, it’s encouraging for the UK that investors have been looking for opportunities close to home, and did so in a year which saw the FTSE 100 fight its way ever closer to the 6,000 mark – a level not reached since July 2011 until a US deal to avoid the fiscal cliff saw markets rally.

“Home-grown companies such as Aviva, Vodafone and even Tesco were all popular investment choices for TD clients in 2012, with the supermarket giant in particular making its first ever appearance as a top ten buy in our clients’ most popular trades of 2012.

“High-street banks, however, still have much to prove if they are to regain trust from British consumers. Lloyds Banking Group maintained its position as the top sell by TD clients for the third consecutive year with Barclays close on its heels in second place. It will be interesting to see what banks do to win back confidence in 2013 and how investors react as a result.”

The European Commission predicts the UK will fast-track recovery in 2013, becoming the fastest growing of Europe’s big five economies. This should be welcome news for investors. The FTSE has risen 3.6% in January so far despite lingering concerns over the US fiscal cliff and debt ceiling negotiations, the eurozone and dismal news coming from large parts of the UK consumer industry.

However, as with any kind of investment, investors should take note that with the uncertainty predicted for the coming few months the markets are likely to remain turbulent.

Asset managers BlackRock think stocks remain attractive, but near-term caution is warranted. In its latest outlook report, BlackRock predicts the pace of the current rally to slow.

“The question that clearly arises from all of this is whether or not the equity rally will continue. For the year as a whole, we would expect equity markets to continue to advance and to outperform bonds, with the best performance likely coming in emerging markets. That said, however, we expect the current pace of gains to slow-if not immediately, then probably by February,” the report said.

“Outside of the political risks, we do have some lingering concerns about the economy. Once we get a look at January month-end data, we will see the first clues about how higher taxes are impacting the economy.

“Notwithstanding some of the stronger data we cited earlier, we are expecting the first quarter to show relatively soft economic data. In particular, we are concerned about consumption levels weakening in January as people come to grips with smaller paychecks.”

BlackRock also feels that all bad news is priced into the market right now, meaning that any negative shock would have the potential to drive markets lower: “The bottom line is that while we think stocks are reasonably valued (particularly outside the US), we would expect tougher going as we head into February.”

Despite this, Mike Niedermeyer, CEO of Wells Fargo Asset Management, says investors need to think of investment into equities as a long term investment: “Investors need to move away from sentiment and focus on the facts. It is a real dilemma that people are not in equities, as the likely return on government bonds over the next 10 years is 2% or less.

“But if you think of the equity market, even if it has more muted returns than the last 20-30 years – it is still likely to get much more significant returns than bonds. Bonds are going to have limited returns in the next decade or so. In the next five years, I see massive outperformance in the equity markets.”