Worrying developments within the corporate sector such as widening credit spreads along with the still nervy backdrop means investors are right to be cautious in the current environment, according to Miton’s David Jane, who is running an average cash position of 11 per cent across his multi-asset funds as a result.
Sentiment towards equities has fallen to very low levels thanks to the recent market rout. Markets have been on a general downward trend for a number of months now, but the events of August (such as ‘Black Monday’) and huge price swings over the last few weeks have left many questioning whether the nearly seven-year old bull market in equities is over.
Performance of indices since March 2009
Source: FE Analytics
“Global equity has passed an inflexion point. The bull market is over. For the moment, let us not argue about the causes … global equity, led by Wall Street, is giving clear and classic signals that the post-March 2009 bull market has run its course,” Hawksmoor’s Jim Wood-Smith said earlier this week.
Some commentators, on the other hand, expect a rally in equities given that slowing growth in China and soggy inflation has pushed back any chance of an interest rate rise.
But while most bears are looking at the world from a top-down perspective, Jane – who heads up the CF Miton Cautious Multi Asset, Defensive Multi Asset, Total Return and PFS Miton Cautious Monthly Income funds – is concerned about goings on within the corporate space.
He says there have been three key developments, the first of which is the rapid deterioration in Glencore’s equity and debt.
Performance of stock versus index in 2015
Source: FE Analytics
Jane points out that with its five-year bonds yielding 8 per cent, there is a serious risk of default. He also adds that Glencore’s woes have led to a broader widening of credit spreads throughout the high yield market – which is worrying as widening spreads is a lead indicator of recessions.
He also says the “shenanigans at VW” are a great concern, given the focus of litigation and regulation may have moved from financials to the industrial sectors, which in turn will weigh on profitability. 
Finally, the manager is concerned about the pharmaceutical sector – an industry earning high margins – due to recent statements made about drug pricing by the likes of US politician Hilary Clinton.
All told, he says these three concerns should be at the forefront of investors’ minds.
“What does this all mean? Our thesis for some time has been that the economies of the US and UK are strong while Europe and Japan are recovering and, therefore, equities should be fairly well underpinned so long as you can avoid exposure to the areas which are suffering; global trade and resources,” Jane (pictured) said.
“These three developments in a market all point to weakening corporate profits one way or another, which is a concern when the market is not obviously cheap.”
“If financing costs are set to rise both due to interest rate rises but also widening credits spreads then one major source of profit growth is under question. Next, if government intervention in the form of litigation for wrong doing and price controls is also set to weigh on profitability we need to reconsider the outlook for profit growth.”
He added: “So the market is worried for good reason.”
Jane also highlights the fundamental relationship between credit spreads and equity prices. While he admits recent credit spread widening has been due to a sharp risk-off feeling among investors given China’s woes, if it continues it could be very bad for equity markets.
“A longer and sustained widening is a fundamental event as it reflects the outlook for corporate profitability as well as being a major factor in determining profitability,” Jane said.
“The weakness at Glencore is very likely to have a knock-on effect on other areas of credit, simply because index and ETF investors will need to sell other credits to fund purchases of Glencore as and when it enters the high yield index. This kind of forced selling is where markets can drive fundamentals as well as be driven by them.”
While the manager says his portfolios are already insulated from falls within many of the sectors he has mentioned so far, he warns there is a chance of contagion and is therefore is happy to leave money out of the market for the time being.
“As we have said often in the past, we have been avoiding resources, energy and have no exposure to car manufacturing. We also have none but the best credits in high yield,” he said.
“However, recent events cause us to be ever more conservative and we are happy to wait on the side-lines with a high cash weighting and relatively low equity weighting pending what promises to be an instructive earning season beginning next week.”
Jane was formerly head of equities at M&G and set up his own boutique (Darwin) prior to his move to Miton in June last year. FE data shows that all of his funds are top quartile in their respective Investment Association sectors over that time.
Performance of fund versus sector since launch
Source: FE Analytics
He has managed his PFS Miton Cautious Monthly Income (formerly PFS Darwin Multi Asset) since June 2011 over which time it has outperformed the IA Mixed Investment 20%-60% Shares sector by 5 percentage points.
The fund currently holds 40.7 per cent in bonds, 36.4 per cent in equities and 8 per cent in property.
