Investors are being priced out of the market – across all assets. For the past year, the City has been calling the bottom on the bond market. Yet, despite predictions that bond yields could not fall any further, US government bonds have done just that. When yields fall, prices rise; meaning bonds are now more expensive than six months ago.
Equities are looking just as pricey, as Tom Becket, chief investment officer of Psigma said last week, after one of the most powerful equity bull markets in the history of man, investors need to be aware that the ripe, low-hanging fruit have all been picked.
“The conflict that we see as fund managers is that most of the assets are now looking fully priced which means it is difficult for us to find returns,” said Marcus Brookes, multi-asset manager at Schroders.
Brookes says the market is so short of high conviction ideas, in his Schroder MM Diversity Tactical fund he has been forced to take a mammoth cash position of 45%.
“According to our analysis, both bonds and equities are due a correction over the next year. We can’t be certain of the timing, so we would rather have as little exposure as possible and risk missing out on incremental rises in asset prices, than have exposure and lose a lot of our investors’ money,” he reasoned.
With such a large cash allocation, it does give Brookes – and his co-manager on the multi-asset suite of funds Robin McDonald – liquidity to act fast should opportunities become available.
“If we are wrong we are at least only one step away from the market, we don’t have to sell anything before re-investing,” he said.
High-Priced Fixed Income
Six months ago bonds did not look attractive. Even in a low inflationary environment, US government bonds and gilts did not offer much of a real rate of return. Then came the polar vortex in the US – wiping the revenue streams of American equities and damaging the economic recovery – and bonds had a bounce. In fact, in the first three months of 2014, bonds outperformed developed market equities.
And the T-bill (US government bond) rally has kicked up a gear over the last couple of weeks – despite the tapering of quantitative easing slowing demand, which should have dampened prices.
“Bond prices rallied recently because many professional investors wrongly predicted the market,” said Brookes. “A lot of hedge funds shorted bonds and when there was a bump in the price they were forced to cover the short and buy bonds. This pushed prices up further.”
If market makers were predicting prices to fall six months ago, now they are insistent the bubble is due to burst.
“Over the past week, yields on 10-year US Treasuries reached their lowest level for a year, while the S&P 500 reached a new all-time high,” said Alan Higgins, chief investment officer, UK at Coutts.
“Neither bond nor equity markets, in general, are cheap. But we believe bonds are clearly the more expensive asset class and the most susceptible to a correction of their gravity-defying trend. Our view that a gradual improvement in the global economic outlook will continue suggests little upside for low-yielding government bonds, with risks skewed toward a rise in yields by year-end.”
Expensive Equities
Yield is still the number one concern of investors – five years on from the Bank of England dropping base interest rate to just 0.5%, according to the Investment Management Association last month the most popular sector among fund investors was UK Equity Income.
Investors are willing to pay through the nose for the privilege of dividends, and as the US market reaches ever more heights some are predicting a correction.
“We believe that following the herd in to relatively expensive US and UK equities is not the key to making healthy returns in the years ahead,” said Becket.
“We view reducing more expensive parts of the world for cheaper investments as tantamount to de-risking.”
Instead, Psigma favour the value markets in North Asia – including Japan, Peripheral Europe and certain emerging markets such as Brazil.
Brookes agrees, and as a result has hardly any US equities in his portfolios.
“European equities look attractively priced compared to both other developed markets and their own historical value,” he said.
“As for emerging markets, we are waiting for valuations to come down a bit more and forecasts to settle down before we invest. After the US has fully unwound quantitative easing by around November, we should hopefully see some opportunities.”
