Interactive Investor

The Analyst: Dzmitry Lipski’s investment insights

The S&P 500 index has recently hit new highs, and for investors who worry about a correction, our head of funds research shares some options to lessen the impact of volatility.

20th February 2024 10:19

Dzmitry Lipski from interactive investor

In this new series of blog content, Dzmitry Lipski seeks to provide actionable insights to help you navigate and better understand financial markets. It aims to help investors generate investment ideas designed to build robust, well-diversified, multi-asset portfolios and profit from market developments.

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SHOULD INVESTORS FEAR A CORRECTION AS S&P 500 HITS ALL-TIME HIGH?

“Be fearful when others are greedy and greedy when others are fearful” - Warren Buffett

Over the past few weeks, the S&P 500 index has reached new highs and breached the 5,000 level for the first time, demonstrating strength in the US economy. Unemployment is low, inflation is under control and the Federal Reserve (Fed) central bank is set to cut interest rates, adding to improved investor sentiment.

But despite the optimism, there is a growing sense of caution that the market rally may meet some resistance, and that we might see some correction in the short term (a correction is typically seen as a decline of 10% or more).

Interestingly, the VIX index - a measure of stock market volatility, risk and investor sentiment used to gauge investor fear - is trading at relatively low levels, below both its three- and five-year averages. This indicates complacency among investors as stock prices hit record highs.

The fear index’

The VIX index gauges expected volatility of the S&P 500 over a 30-day period by aggregating pricing of call and put options on the index itself. It is considered a leading indicator for both the S&P 500 and the wider stock market.

A lower VIX reading - typically lower than 20 - indicates less fear in the market, whereas a higher VIX - above 20 - usually shows greater volatility. As such it can be used as a contrarian indicator.

The VIX generally tends to have an inverse correlation with the S&P 500 - as one index rises, the other falls. So when spikes in the VIX coincide with sharp drops in the S&P 500, 0history tells us it’s time to go bargain hunting. Similarly, when the VIX reaches a low point and investor complacency is high, a cautious approach should be taken.

The chart below shows that the opposite trend between S&P 500 & VIX has reached extreme levels: 5,006 for the S&P versus 14 for the VIX.  

Source: Morningstar Direct. S&P 500 PR and CBOE Market Volatility (VIX) VIX/S&P as at end of each month from 30/04/2004 to 16/02/2024.

Do not fear new highs – stay invested

While investors can monitor the VIX, it is almost impossible for investors to accurately determine the top or bottom of the market. And there remains the risk of buying at extended levels when you should actually be selling, or selling after a market fall when you really should be buying.

Currently, the market may see further uncertainty and volatility, and it is important to remember that the best investment outcomes are often achieved through time in the market, not timing the market.

In addition to conventional defensive assets such as bonds, gold and healthcare stocks, investors looking to lessen the impact of volatility can consider minimum volatility strategies. Over time, low volatility stocks have shown higher average returns than high-volatility stocks.

A good option is iShares Edge S&P 500 Minimum Volatility ETF USD Acc (LSE:SPMV), which tracks the performance of an index composed of selected companies from the S&P 500. These companies collectively exhibit lower volatility than the broad stock market, while maintaining characteristics such as sector and factor exposure similar to the S&P 500. The ongoing charges figure (OCF) is 0.20%

Other iShares exchange-traded funds which employ a similar strategy include iShares Edge MSCI World Minimum Volatility ETF $ Acc (LSE:MVOL), iShares Edge MSCI Europe Minimum Volatility ETF €Acc (LSE:MVEU) and iShares Edge MSCI EM Minimum Volatility ETF $ Acc (LSE:EMMV)F.

Dzmitry Lipski is responsible for fund selection and portfolio construction at interactive investor. 

 

Blog entry: 7 February 2024

GOLD, SILVER OR BOTH?

In the past, gold has performed well relative to equities and other risk assets during periods of extreme economic turbulence, market volatility and high inflation. As such, it’s widely considered a safe-haven asset. Recent heightened geopolitical risk and dovish outlooks from major central banks have both supported the prices of the yellow metal. Subsequently, the price of gold has risen almost 15% in the last year to over $2,000 per ounce.  

Similar to gold, silver is also considered a good hedge against inflation and a reliable store of value during economic and geopolitical uncertainty. It also has more industrial application than gold and is used extensively in energy-efficient industries such as solar and electric vehicles. This means that including silver in investment portfolio offers the potential for higher returns than a pure gold allocation. 

Historically, silver and gold have a close relationship, with a correlation coefficient of 65% over the past 10 years. As such, silver prices tend to move in tandem with gold and typically increases in value faster than gold when precious metal prices are rising.

The outlook for gold and silver, and commodities more generally, is more favourable given the possibility that interest rates in developed counties have peaked and will likely be cut this year. Lower rates and expectations for a weaker US dollar should increase the appeal of both gold and silver as they are priced in dollars. Growing demand for clean energy metals should also support silver prices.

A popular indicator to time your trade

For experienced investors, look at the gold-to-silver ratio as an indicator of when to invest in which of the metals. The ratio is the amount of silver needed to purchase one ounce of gold.

The chart below shows the fluctuations of the ratio since 1913. A popular rule of thumb is the 80/50 rule, which suggests switching to silver when the ratio value rises above 80 ounces of silver per one ounce of gold, and switching to gold when its value drops below 50 ounces per ounce. The current ratio is around 90 to 1, which indicates that gold is looking expensive relative to silver.

Although the gold-to-silver ratio offers a simple and useful guide for precious metal investors, there are many more variables to consider when assessing the value of gold and silver. As always, it’s important to do your own research, and fully understand how the investment fits your strategy.

In addition to generating extra return, maintaining a certain percentage of a portfolio in gold and silver can increase diversification and reduce the risk of the overall portfolio.

Investors can gain passive exposure to precious metals via simple, low-cost exchange-traded funds (ETFs) such as iShares Physical Gold ETC (LSE:IGLN) and iShares Physical Silver ETC (LSE:ISLN).

Alternatively, investors could also consider actively managed Jupiter Gold & Silver fund. It invests in both physical gold and silver bullion, as well as gold and silver mining companies, and can adjust exposures depending on the prevailing market conditions. 

Dzmitry Lipski is responsible for fund selection and portfolio construction at interactive investor. 

 

Blog entry: 30 January 2024

JUSTIFYING UK EQUITY HOME BIAS IN RETAIL INVESTOR PORTFOLIOS

Income remains a key theme for investors and will remain so, especially when interest rates begin to fall. ii’s Head of Funds Research shares his thoughts on generating income from a UK-focused portfolio.

As part of a global trend, both the number and size (market capitalisation) of UK companies have declined over the last few decades. In the 1990s, the UK accounted for more than 10% of global stock market indices such as the FTSE All World index but is now just 4%. That means any UK investor with an allocation above that level exhibits a home bias. In contrast, the US market accounts for staggering 61% of the index.

Institutional investors such as insurance and pension funds have been gradually reducing home bias within equity allocations and jointly held a total of 4.2% of UK-listed shares in 2022, the lowest on record.  Their holdings in UK shares have fallen since 1997 when the two sectors held a combined 45.7% (Source: Office for National Statistics, Ownership of UK quoted shares: 2022).

What about UK retail investors? Looking at the MSCI PIMFA Private Investor Balanced Index, the average allocation to UK equities in retail investor balanced portfolios is still around 20%, emphasising the material bias towards the UK market. 

Should you be concerned about these numbers? I believe that investment decision should be guided by fundamentals and valuations, not the composition of global indices.

The UK is a diverse and developed market offering investment opportunities across a range of sectors. It is home to a number of well-established global companies, many of which derive a good deal of their revenue from overseas. This means that for UK investors, UK equities can provide indirect exposure to global markets without currency risk.  

UK dividends continue to grow, supported by dollar-based earnings from most of the country’s largest paying companies such as HSBC (LSE:HSBA). According to the latest Computershare UK Dividend Monitor report, UK dividends grew 5.4% in 2023 and are expected to grow at slower pace of 3.7% in 2024, offering a superior yield to bonds, having slipped below them during much of 2023. Growing dividends should further improve the UK’s appeal as a high-yield market.

Index

Return: 1 year (%)

Return: 3 years

Return: 5 years

Forward PE

Current yield

FTSE All-Share

7.92

8.61

6.61

11.16

4.11

S&P 500

19.17

12.59

15.66

19.85

1.50

FTSE All World

15.69

8.76

12.20

16.33

2.07

Source: Morningstar as at 31 December 2023. Total Returns in GBP. Past performance is not a guide to future performance.

Although the economic situation in the UK remains challenging and may not look reassuring for the equity market, valuations continue to look attractive, both historically and versus other markets, especially the US. There are clearly still stocks out there that can reward patient investors with attractive returns.

Popular ways investors choose to play the theme include:

iShares Core FTSE 100 ETF GBP Acc GBP (LSE:CUKX): this is the largest exchange-traded fund (ETF) for passive exposure to the 100 largest UK-listed companies. The ongoing charge is just 0.07%.

Artemis Income: the fund aims to provide investors with a steady and growing income along with capital growth over the longer term. It mainly invests in UK companies but has the flexibility to invest overseas when attractive opportunities arise. The portfolio is well diversified, typically owning 50 to 70 holdings which tend to be stable, well-established businesses with the financial strength to pay solid dividends to shareholders.

The fund’s managers Adrian Frost, Nick Shenton and Andy Marsh have many years’ experience managing income strategies. Artemis Income Fund is a solid, core UK large-cap equity income option for investors. Current yield is over 4%.

Dzmitry Lipski is responsible for fund selection and portfolio construction at interactive investor. 

 

► Blog entry: 23 January 2024

US EARNINGS SEASON – TRADE IT OR FADE IT!

As American companies publish quarterly results, major stock market indices are hitting record highs. ii’s Head of Funds Research shares his thoughts on some new analysis of stock market performance and forecasts for 2024.

Last week the S&P 500 index hit a record high for the first time in two years, topping the 4,800 level, but I believe more upside is only possible if company earnings beat already optimistic expectations.

According to the latest report from data provider Factset, the projected earnings growth rate for the S&P 500 in 2024 is 12.2%, which is pretty punchy and way above the 10-year average earnings growth rate of 8.4%.  

At sector level, all but one of the 11 sectors (Energy) are predicted to report earnings growth in 2024. Six of these are projected to report double-digit growth, led by the Healthcare, Communication Services, and Information Technology.

 

Past performance is not a guide to future performance.

The S&P 500 also looks expensive on a forward price/earnings ratio of 19.5, which is above both the five-year and 10-year averages at 18.9 and 17.6 respectively.

The bottom-up target price for the S&P 500 is 5,233.85. At the sector level, Energy (+25.7%) is expected to see the largest price increase, and Information Technology (+6.2%) is expected to see the smallest price increase.

Just because stocks look expensive, it doesn’t necessarily make them a sell; not all of them anyway. There are some big themes at play which explain the excitement, most obvious being artificial intelligence (AI). It’s only just started to play out and clearly has a long way to run. It’s been a case of FOMO in the past months – everyone wants a piece of the action. But stock prices never go up in a straight line. This is a trend for the long term that you either buy and tuck away, or trade on the way up if you prefer that approach.

And, of course, from a big picture perspective there’s the current will they, won’t they? debate about interest rates. Expectations of a first cut in May have been baked into share prices, so any deviation from that consensus will have negative consequences for equity markets. We saw what happens when this occurred at the start of the year. Central bank policymakers have rarely been so powerful.

Given ongoing concerns about slower growth and the threat of recession, investors should tread cautiously and maintain a well-diversified portfolio.

Whatever your view on markets, a well-diversified portfolio makes it easier to successfully navigate economic uncertainty and market volatility. It also gives the best chance of generating a positive outcome whatever the market throws at you.

Dzmitry Lipski is responsible for fund selection and portfolio construction at interactive investor. 

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.