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Why Panic and Investing Shouldn't Mix

Editor's Views: More than 10 years on from the financial crisis, investors are now fretting about bonds rather than bad banks, but recession fears may be overblown

Holly Black 16 August, 2019 | 10:37AM

editor

The R word has reared its ugly head this week, after yields on US and UK government bonds inverted for the first time since 2007.

Recession Fears

For the uninitiated, an inverted yield curve means investors receive a greater return for lending their money for, say, two years rather than 10. Crucially, it is often seen as a precursor to a recession because it suggests there is far more to be worried about in the short-term than off into the future – yields come down on the longer-term investments such as 30-year bonds because demand for them is greater as they are perceived as being safer. 

In the US this has proved an incredibly reliable litmus test for recession over the decades;  the UK, less so. But the term recession is enough to make many investors panic – it will likely bring back memories of the global financial crisis of 2007/08.

Of course, this scenario is rather different: 2007 was about toxic banking loans blowing up, 2019 is about uncertainty – whether it be Brexit, trade wars or central bank policy, we’re in no shortage of uncertainty at the moment. Still, there are reasons to be cheerful: unemployment is at record lows, stock markets are soaring, and business balance sheets are in pretty good shape.

Like so many things, whether we’re headed for a recession or not is uncertain. But remember, panic and investing don’t usually go very well together (a bit like pineapple on a pizza). Yet some people still insist on it (a bit like pineapple on a pizza).

What am I getting at? That a potential recession doesn’t really mean much for your investment portfolio. Sure, you can take measures such as hedging, as our analyst Mike Coop suggests or you might consider ETFs that invest in gilts, but if you’re unsure the best thing is usually to do nothing.

More to Come

It was worrying to see the collapse of another mini-bond firm this week. The collapse of Asset Life could leave 500 investors out of pocket by a total of £8 million. It comes just months after the high-profile collapse of LCF, which went under owing £240 million.

While it’s reassuring to see that the Financial Conduct Authority is starting to get a tighter grip on this sort of thing, it indicates that the widespread marketing of these mini-bonds really should never have been allowed.

It's all very well telling investors to be skeptical of an investment paying 8% or 9% interest, but wouldn't it be better if these products hadn't been able to market themselves in the first place? I fear this is not the last mini-bond firm that will hit the headlines; the regulator may be playing catch up for some time to come with firms that have already slipped under the net.

Another Michael Lewis Reference

Shorting has been a big topic of the week as the spat between Burford Capital and Muddy Waters rumbles on. Short-selling is one of those investment words that sounds a bit dirty and spurious, and makes you think of a Michael Lewis book (I promise I’ve not got a deal with this guy, his books are just relevant at the moment).

Yet many investors might be surprised to learn that shorting is a tool commonly used by many fund managers to make genuine calls about companies they think are overrated and often as a sort of insurance policy in their portfolio. When you think about it like that, suddenly shorting isn’t half as interesting. So many things about investment get glamorised or demonised, when they often usually just pretty boring.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Holly Black  is Senior Editor, Morningstar.co.uk

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