The possibility of heightened market weakness or even a significant correction has been one of the major talking points in the industry, with several high-profile managers raising their cash weighting on the back of the stretched valuations and a lack of implied volatility.
Headwinds such as rising interest rates, instability in the Middle East and Ukraine and weak economic data out of Europe have all been mentioned as possible causes for a sell-off.However Merricks, head of investments at Skerritts, says that as so many investors are cautious at the moment, the chances of a huge fall in equity markets are low.
“There has been a sense of foreboding regarding the levels to which markets have climbed. Any number of reasons have been put forward as to why they are due a correction, or in some cases why they are about to enter a bear market phase,” Merricks (pictured) said.
“In short, investors are frightened to be in the market for fear of a loss, but at the same time they are frightened to be out of the market for fear of missing out on continued returns.”
“What seems to be missing at the moment is mania, which is as good a forecast as any as to why we’re probably not close to a major correction.”
Merricks understands why so many investors are de-risking their portfolios, especially as the UK market has delivered almost uninterrupted gains since the equities bottomed after the global financial crisis in 2008.
Performance of index since Mar 2009
Source: FE Analytics
However, Merricks says a lot of managers who are holding cash in the expectation of a crash are now doing so out of hope it will eventually justify their decision, but there aren’t any signs to suggest we are in bubble territory just yet.
“Charles Kindleberger in his ‘Manias, Panics and Crashes’ came up with the wonderful phrase: ‘There is nothing as disturbing to one’s wellbeing and judgement as to see a friend get rich’ which is as good a summary of what drives a bubble as any that we’ve seen.”
“Whether it be stocks, property or any asset class, it is the scramble to copy what has made others in your circle wealthy that has fuelled many an ill-informed and expensive purchase. The loose credit of the decade leading up to 2008 was the petrol on the pre-crash flames.”
“Now, however, even though interest rates reward no-one and with the FTSE 100 more than doubling since the trough of March 2009 there is not the sense that the public is clamouring to invest for fear of missing out, which is one of the symptoms that we look for ‘pre-crash’.”
One of the major reasons why Merricks thinks the market can keep grinding higher is because we are in a prolonged low interest rate cycle. He says it is unlikely that rates will reach 5 or 7 per cent again for a long time to come.
Nevertheless, he says investors shouldn’t become complacent as he doesn’t think the market will surge like it did in 2013.
“If we are right about a prolonged low interest rate cycle, then we may be able to expect a longer period of market gains for a while yet. That is not to say that gains from here will be easy to achieve. It will be hard work keeping investors happy,” he said.
One of the portfolios Merricks uses for his UK equity exposure is FE Alpha Manager Alex Savvides’ JOHCM UK Dynamic fund.
Savvides launched the £240m fund in June 2008 and, according to FE Analytics, it has been a top decile performer in the highly-competitive IMA UK All Companies sector over that time with returns of 116.3 per cent, beating the FTSE All Share by 61.09 percentage points in the process.
Performance of fund vs sector and index since June 2008
Source: FE Analytics
The fund has outperformed the sector and index in each calendar year since its launch, except for the falling market of 2011.
JOHCM UK Dynamic is a type of special situations fund as Savvides will typically target out-of-favour companies that he believes will see a reversal in fortunes; such as if there is a change in management for the better or if competition suddenly diminishes.
However, the manager will only invest in companies that pay a dividend, or will pay a dividend over the coming 12 months.
Merricks says he is happy with that exposure, but if for any reason he did want more cautious exposure to UK equities he would turn to Savvides’ colleague and fellow FE Alpha Manager, John Wood, who runs the five crown-rated JOHCM UK Opportunities fund.
Performance of fund vs sector and index since Nov 2005
Source: FE Analytics
Our data shows the £1.4bn fund has been a top quartile performer in the sector since its launch in November 2005, but Wood runs a more defensive portfolio of mega-cap stocks which means returns have tended to be lower than Savvides’ fund over recent years. Wood also currently holds 19 per cent of his fund in cash.
JOHCM UK Dynamic has a yield of 3.23 per cent and an ongoing charges figure (OCF) of 0.94 per cent.
Wood’s fund has a yield of 2.95 per cent and an OCF of 0.82 per cent; though both portfolios have a performance fee of 15 per cent.
Skerritts says that he sees no reason why he needs to move out of Savvides’ fund, however, as the lacklustre returns from the FTSE All Share so far this year are unlikely to continue.
Performance of index in 2014
Source: FE Analytics
He likens current market conditions to being stuck in traffic jam on the motorway, although there seems to be no apparent reason for the queues.
“Heavy traffic can travel at quite a high speed as long as everyone does the same thing. It only needs one thing to throw this askew though,” Merricks said.
“The flow will become destabilised as brakes are applied, lanes are changed, and everything slows down until it can stabilise itself once more, before gradually picking up speed again to move ahead in unison.”
“Until the start of this year markets had been moving ahead quite quickly in the same direction for a long time, so a period of instability as they re-set themselves is to be expected. Our view is that much of 2014 has been a ghost jam and we are not coming to a grinding halt due to a major accident.”
He added: “We are drumming our fingers on the steering wheel in annoyance but, at this stage, we’re not looking for an exit or an alternative route.”
