Perhaps, but a large number of fund managers at their desks over the summer, such as FE Alpha Manager David Coombs, have told us that they are keeping a high proportion of their assets un-invested due to fears that a sell-off in the equity market is long overdue.
On the face of it, it does look like something has got to give.
Following a period of very strong returns since the market bottomed after the last serious financial crisis, the S&P 500 has just closed at its highest ever-level and FTSE, at 6,800, is close to breaking its own record.
Performance of indices since March 2009
Source: FE Analytics
The major reason why some are sceptical of the rally continuing is that earnings growth has yet to really materialise, stimulus from the US Federal Reserve is being withdrawn and implied volatility is at historically low levels.
These issues alone may not have the power to cause a correction, but bears say they are all making the market less immune to potential headwinds for continued asset prices gains or the health of the global economy.
Rising rates
One obvious concern, according to a high proportion of managers we have spoken to recently, is the prospect of rising interest rates here and in the US.
The Bank of England has already alerted the market that it plans to tighten monetary policy by raising rates and a number of managers have started to protect their portfolios from such an event.
The major fear is that, as everyone has become so used to the ultra-low rate environment, the initial move upwards would cause both equity and bond markets to correct as investors attempt to lock-in profits. Then there are also longer-term consequences of higher lending costs.
“We are definitely concerned about it [higher interest rates] because we have had such benign conditions over recent years,” Charles Hepworth (pictured), investment director at GAM, said. “However, I don’t see it as a concern for September or even 2014. There has been no real indication that rates are going to go up sooner than expected and it is extremely unlikely as we get closer and closer to the general election in May.”
Tom Becket, chief investment officer at Psigma, agrees that higher interest rates could cause volatility but, in all likelihood, the concerns have been over-played.
“Our current view is that the Bank of England starts to raise rates in January and the Fed will do the same in early summer 2015,” he said.
“In terms of the impact that will have on markets, it has been so well-telegraphed that I can’t imagine it would cause a real problem because they will only be incremental movements.”
“The problems would arise if they go up more quickly than expected, if they are pushed higher to combat higher wage inflation or if they go up when there is a lack of liquidity in the corporate credit market.”
European worries
The next major headwind which is causing several managers to de-risk their portfolios is Europe, which has been a perennial source of bad news over recent years.
The eurozone was on the verge of collapse in 2011, but serious returns have been made by investors who bought European equities following ECB president Mario Draghi’s “do whatever it takes” speech in July 2012.
Performance of sector and index since July 2012
Source: FE Analytics
However, the threat of a Japanese-style deflation spiral, tied in with still lacklustre economic growth and a mounting debt burden, has meant that the region has been in the headlines for all the wrong reasons again.
Becket says the issues surrounding Europe cannot be ignored but, at the same time, it is hard to say whether it will have the power to cause a significant sell-off because the ECB looks like it is willing to step in to defuse any potentially disastrous situation.
“Europe is a real basket case,” Becket said. “There were early signs of a recovery but then it seems it is falling back into recession. The economic outlook is rubbish, the politicians are useless and the ECB has been left to do the heavy-lifting.”
“Europe is a problem and a clear and present danger. However, would it stand in the way of the equity market going higher despite that? Probably not.”
However, Hepworth says the upcoming asset quality review for European banks could create volatility if the results of the stress test are soggy. Despite that, he agrees with Becket that Draghi’s rhetoric is likely to remain very supportive for markets.
Geo-politics
Though higher interest rates and Europe have caused concerns, the largest potential worries have been those surrounding geo-political tensions.
FE Alpha Manager William Davies told FE Trustnet earlier this week that he had made his portfolios more defensive following the crisis brewing between Russia and Ukraine.
The major concerns are the impact of sanctions from the West and East will have on the global economy, let alone the potentially devastating situation heightened tensions would have on the world. Some have already been drawing parallels between the current environment and the summer of 1914…
Throw in the tensions in the Middle East and there certainly seems to be cause for concern.
However, while Becket says the potential dangers are all too clear to see, it isn’t a risk that investors can do anything about.
“There are geo-political risks out there, but then they aren’t something you can prepare for,” he said. “Also, if you look at the real safe-havens such as gold and oil, neither of them have budged an inch which suggests that investors are quite relaxed and are probably right to be.”
Performance of indices over 3 months
Source: FE Analytics
Both Becket's and Hepworth’s relatively sanguine outlooks shouldn’t be misconstrued as complacency, though, as they say the huge amount of central bank intervention over recent years has had a huge distorting effect on financial assets which could cause problems further down the line.
“I am surprised that volatility hasn’t spiked more, but I suppose that is just the world we live in where every asset class keeps getting pushed up. You’ve got to wonder what will happen when the music eventually stops, but that isn’t in our forecasts just yet,” Hepworth said.
The two managers also say the problem with significant sell-offs is that they happen without any real warning and catch most by surprise.
Becket says that, excluding a black swan event, investors shouldn’t feel the need to make wholesale changes in their portfolios over the risks mentioned in this article.
“These risks are unhelpful and anything that is unhelpful appears to be a much bigger problem when valuations are stretched, as I think they are now, than when they are low,” Becket said.
He added: “It’s quite difficult to call how markets will perform over the next few months, but I’m not massively bullish and I’m not massively bearish, I’m just quite bored of it to be honest.”
