Stephens, managing director of the firm, says it’s surprising that equity markets have stayed in positive territory this year in spite of these very real risks – especially as they’ve performed so well since 2012.
He still thinks equities are the most attractive asset class, but thinks the time has come to be more vigilant.
“It is difficult to assess at the time whether [black swan events are] significant,” he said. “They can often be incorrectly priced into the market as irrelevant, only for them to rear their head with a vengeance a few months later.”
“The most recent example of this was the early warning signs of the credit crunch in the US sub-prime mortgage market. Initially it was felt it was an isolated issue in a small part of the US mortgage market and would cost at most $250bn.This view persisted for around six months until Lehmans imploded.”
“We have had three similar potential events so far this year in the guise of the Chinese shadow banking system, Putin’s invasion of Ukraine and the Sunni uprising in Iraq. All three have caused some market weakness, only to be discounted as irrelevant and the buyers have come back in and driven the market back up.”
Performance of indices in 2014
Source: FE Analytics
FE data shows that all of the major indices are up year-to-date, with the exception of Japan. Even the MSCI Russia index has made back the vast majority of its losses.
“Even if you sell, this is only in the hope of buying back in at lower prices as other asset classes look very second rate, [which is] why the buyers have ignored the potential black swan events, perhaps at their peril. Time will tell,” Stephens added.
He adds that the withdrawal of quantitative easing in the US and UK, and the possibility of UK interest rates rising as early as this year have also been shrugged off by investors.
As well as equities performing solidly this year, bond markets have also held up well. Rising interest rates and QE tapering have long been seen as enemies to fixed interest, but all of the major IMA bond sectors have made money in 2014.
Performance of sectors in 2014
Source: FE Analytics
Valuations are elevated across most developed markets, with the S&P and FTSE now trading above their 10 year historic averages from a price-to-earnings point of view.
Disappointing earnings growth has led to some significant stock market falls – online retailer ASOS is down more than 50 per cent year-to-date, for example – but these three macro events haven’t yet sent markets falling in any significant way.
A number of high profile managers including Newton’s Iain Stewart and Investec’s Alastair Mundy have expected falls of at least 10-15 per cent for some time now, but they continue to wait on the sidelines in significant quantities of cash.
Stephens thinks earnings growth will improve this year, even though he thinks macro concerns could plague markets.
He thinks problems in China are most likely to cause a meaningful pullback.
“There are reasons to be nervous with regard to US equity market valuations but then again, there is significant momentum behind the stock market and once the earnings for the second quarter hopefully bounce back from the weak first quarter, the elevated valuations may appear justified,” he said.
“The most likely black swan is the Chinese shadow banking system which has supported their infrastructure boom and the effect this could have globally.”
“However, the fact it can be seen and assessed somewhat defeats the definition of a black swan in the first place and they have continued to extend their building spree into next year.”
Head of asset allocation at Fidelity Trevor Greetham remains positive on equities in the medium term as strong GDP growth and low inflation tends to favour risk-assets.
He has been taking profits across Fidelity’s multi-asset portfolios recently, believing there could be an opportunity to add to his overweight in the coming months.
“At present growth indicators are mixed and inflation pressures have risen on the back of a higher oil price,” he said.
“The model that guides our asset allocation is the closest to neutral that we can remember.”
“We took some profit in equities earlier in the year as growth indicators weakened and we are hopeful the growth picture will resolve in a positive way after the summer.”
“A seasonal rise in volatility may provide the opportunity to rebuild a larger overweight in equities.”
The FTSE is down 0.6 per cent today at time of writing, at 6,743.