How should investors think about the risk in stockmarkets, as the FTSE 100 index nears an all-time high?

COLIN McLEAN

How should investors think about the risk in stockmarkets, as the FTSE 100 index nears an all-time high?  Is it too late to buy shares?

Stockmarkets appear volatile, yet the surprising pattern of 2015 is that most of the short term risk has moved to currencies. Much of this is driven by movement in the US dollar and commodities. Weak energy and commodity prices have tightened the supply of dollars globally, and put pressure on emerging economies that rely on those exports. Dollars are no longer cheap riskless finance, and oil producing countries have fewer to spend. In turn, the dollar shortage creates deflation, as the prices of commodities expressed in dollars are cut. The strong dollar, as borrowers try to re-pay debts, translates into weakened emerging market currencies.

It is a relentless downward price spiral. And, despite a belief that inflation will return globally, - and even signs of that in Germany - this dollar cycle has yet to break. Indeed, the underlying supply of dollars may even be tighter than it looks, given unrealistic currency pegs and dollar borrowing that is mismatched. The world's risks appear very dependent on the dollar, and in particular whether the American economy will strengthen enough to allow its interest rates to rise. This year, poor winter weather has confused economic data. But, recent trends in coal and lumber prices, and in goods shipments, are not encouraging.

China plays a role in the currency stresses, and many indicators point to a China credit bubble. Whether measured by money growth, credit or house prices, there are parallels with the US financial boom that ended abruptly in 2008. Indeed, China's stockmarket now looks as frothy as Western markets did in 2007. The average valuation for China A shares has almost doubled in 12 months. And, although some markets have printed money and delivered a stockmarket boom with a devalued currency, China's Renminbi is pegged to a currency basket. That looks unsustainable, as Asian competitors devalue around it. The Japanese yen is at an eight-year low versus the dollar.

While it appears that China is driving global growth, it is driven by an unsustainable credit boom. Instead, the locomotive for the global economy remains the US, with many emerging economies still unwinding property bubbles or overly exposed to commodities. Europe is early in its economic recovery, driven by the lower oil price and the euro devaluation.

Adding to risk, global markets seem particularly interconnected currently, and liquidity in many assets is relatively low. The world's stockmarkets and asset classes have become more correlated. It is harder to reduce risk simply by spreading investments. This is the surprising result of printing money, which has poured money into shares and bonds, without creating the same scale of a genuine two-way trade.

Recently, the UK economy has moved to deflation, for the first time since records began in 1960. Those with long memories may view the move as temporary. It was less than two years after deflation in 1960 before inflation was up at 6per cent. But conditions are not set up for a repeat. Now, there are few signs of the rapid growth that the 1960s generated. Investors' recent worry about inflation re-igniting could prove premature. For two years, central banks, including the Bank of England, have reiterated their confidence that deflation will be avoided. It would take a much higher oil price to change things.

With so many risks around, many will sit on cash. But, governments appear to be determined to print money - boosting financial assets, even if it devalues currency. Investors should also look at individual company prospects, and the growth that some good management teams are achieving. There will always be economic and stockmarket risks. Investors need to assess their overall mix of assets, and their personal comfort zone.

Colin McLean is managing director at SVM Asset Management