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The equity-bond battle: Which market is right?

by Eleanor Lawrie on May 28, 2014 at 15:17

The logical response to the situation was for investors to rid themselves of some of those overpriced equity holdings. ‘Simply put, now does not appear to be an appropriate time to be holding on to equity exposure, let alone buying more.’

Limited valuation support

David Vickers, senior portfolio manager on Russell Investments’ flagship £1.2 billion Multi Asset Growth Strategy fund, is also more cautious on equities compared with a year ago. ‘In the equity market, there is not much valuation support, but the risk premium is a little elevated. We have seen peak earnings and peak valuations, and if you are at the higher end of the spectrum the probability of a fall is substantial.’

To counteract a potential drop, Vickers has bought put protection in the fund, which means equity markets could fall as much as 12%, and his portfolio would behave as if it had less than 10% in equities.

Despite this defensive measure, he thinks equities will outstrip bonds this year, but is reassured by low default rates so expects some areas of fixed income to provide a more dependable return.

 ‘We believe equities will outperform fixed income but we are not going into a recession anytime soon. Europe is getting better and for the first time since 2012, the G3 economies are all pushing in the right direction. Default rates will continue to be low, and in a world of low returns I have a higher conviction that I can get 5% from loans and high yield than 7% from equities.’

Clearly this simultaneous rise cannot go on forever, and which asset class you favour going forward will depend on your world view, and predictions of what central bankers will do next.

However, as David Lebovitz observed: ‘It’s the unforeseen shocks that rattle markets the most.’ In such a contradictory environment, investors need to consider how to protect themselves from a correction in either market, which will mean a degree of diversification.

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