Davies, who is the asset management house’s head of global equities and runs the £887.7m Threadneedle Global Select fund, argues that a recent reversal of globalisation caused by soaring geopolitical tensions is likely to lead to a low growth environment in the near term.The FE Alpha Manager adds that this is particularly true when it comes to the Ukraine crisis, where sanctions between Europe and Russia still have the potential to escalate.
He said: “Pressure is above all on European stocks, global companies with European and Russian exposure and those companies which have benefited from the ‘Draghi put’ effect. This may sound alarmist, but I think it’s time to take a more defensive equity position.”
Threadneedle Global Select is underweight Europe with 12.7 per cent in the region against the 16.5 per cent in its MSCI All Country World benchmark.
The fund’s largest geographical weighting is to the US at 57.5 per cent, over the index’s 52.6 per cent, while the manager also favours Japan.
In his outlook for 2014, Davis previously tipped the eurozone to grow for the first time in three years, the S&P 500 to return more than 10 per cent and Japan to broadly match the US in terms of economic growth, thanks to Abenomics.
He expected earnings growth of about 10 per cent in US and Europe, with Japan’s being better, and remained positive on China.
“Now I’m not so sure. Such an economic scenario remains a possible outcome, but increasingly I’m becoming concerned about the mounting examples of nationalism around the world.”
“While nationalism is not a new phenomenon, many of the fruits of the past 30 years have been helped by globalisation. Its reversal could lead to a far less attractive economic picture.”
Offering examples of nationalism in today’s world, the manager highlights Russian president Vladimir Putin’s stand-off with the international community over Ukraine, India’s scuppering of the World Trade Organisation’s plans to pull down trade barriers across its member states and a shift towards more nationalist parties in Europe’s recent elections.
Performance of world indices in 2014
Source: FE Analytics
But Davies’ main concern is the tension in Ukraine, which is facing a secession crisis following unrest in its eastern and southern regions.
Armed separatists are attempting to split from Kiev, with the support of the Russian government, and tension spiked when the Malaysia Airlines MH17 passenger flight was downed over the Donechchyna province.
The European Union and the US have hit Russia with a series of reprisals for its support of the separatists, with some sanctions targeting the country’s energy and arms sectors and others putting asset freezes and travel bans on senior Russian officials and separatist leaders.
Davies said: “My concern is that the Ukraine crisis has consequences beyond its borders. A century on from the outbreak of the First World War, there is much talk about the fluttering of a butterfly’s wings and unintended consequences. The comparison may be far-fetched, but it does highlight the dangers of escalation. Let’s hope that the memory of 1914 serves to make this less likely today.”
The biggest risk to markets from all this is economic, he adds. Following the EU and US sanctions, Russia suggested Europeans would end up paying more for energy by the time winter arrives and said airspace for European airlines may be limited. Russia has also placed import bans on some Western goods.
Despite this, there are some positive signs. The EU and Russia worked together on a humanitarian convoy to eastern Ukraine showing cooperation can take place while some commentators have suggested that the crisis may not escalate as quickly as originally feared.
Davis added: “However the risk of further sanctions remains which would threaten European and Russian growth directly, and global GDP implicitly. We don’t know how far the sanctions will go, but the margin for error between growth and recession is pretty narrow in Europe, which represents about a quarter of the world’s GDP.”
Figures from EU statistical office Eurostat show GDP across the region grew by just 0.2 per cent in the second quarter of 2014, easing from the 0.3 per cent seen in the opening three months of the year.
At the recent Jackson Hole central bank symposium, ECB president Mario Draghi acknowledged the weakness being seen in the eurozone economy and hinted that the central bank may act again.
The manager said: “We are faced with a world where conflict is becoming more commonplace, nationalism is rising, borders are closing, trade is becoming disrupted and economic activity is under increasing pressure. A return to contraction could have serious implications for Europe and ultimately the rest of the world.”
“With the potential for escalation of sanctions remaining a live issue, equities should command a higher risk premium. It is impossible to judge accurately how high this should be, but as stewards of investors’ capital our job is to protect portfolios. We believe it is time for a more defensive position.”
Davies has managed Threadneedle Global Select since the start of 2012 and, according to FE Analytics, it has returned 40.36 per cent over that time, beating the IMA Global sector average which has returned of 38.70 per cent.
Performance of fund and sector over 2yrs
Source: FE Analytics
The fund has clean ongoing charges of 1.05 per cent.
