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Calm before the storm: what will tip markets over the edge?

by Eleanor Lawrie on Jun 25, 2014 at 07:00

Calm before the storm: what will tip markets over the edge?

As we head into the summer months, investment managers say the market is heating up and they are struggling to find fair value homes for their clients’ money. Fixed income yields little, while the FTSE 100 has flirted with all-time highs at several points since the start of the year.

With both equities and fixed income looking expensive, and the emergence of macro-political concerns in Eastern Europe and the Middle East, there are fears we are due for a correction.

 ‘We are in a situation in the US, Europe and other developed markets where equity valuations are not cheap, as people have been adding risk to their portfolios for the last 18 months,’ said Kerry Craig, global market strategist at JP Morgan.

‘From the end of December last year, the expectation was that core government bond yields would rise as earnings went up, but yields [have fallen]. At the same time as equities looked fairly valued, bonds became more expensive and that caught investors out.’

As a house, JP Morgan still favours equities, but at a more modest overweight than last year, when the FTSE returned 20%, a feat it is unlikely to replicate in 2014.

‘We still think it’s the right place to be but given where valuations are, it’s about finding quality companies - it’s about looking at the micro as well as the macro,’ Craig said.

‘The fact that markets are high means investors have to be much more careful about where they are investing, and looking for earnings growth coming through.’

‘Another risk that could add volatility is central bank policy, with [Bank of England governor Mark] Carney or [Federal Reserve chair Janet] Yellen bringing about a rise in interest rates. A few months ago, Carney said rates would not rise until the middle of next year. Now he is saying that could happen sooner than expected, and investors have to prepare themselves for this.’

While government bonds could hardly be described as good value, Craig argued they do have a place in a portfolio, as they will protect you if there is a big macroeconomic scare, the one thing that really could prompt a correction in markets at the moment.

‘They do provide an important place in a diversified portfolio because they provide security, so if you do get a flare up in Ukraine, or a civil war in Turkey, you get that protection from volatility and a layer of reassurance.’

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