“We are most worried about US small cap,” says Stammers. “There is a clear correlation between US small cap and US interest rate hikes, and the US equity market has a rocky patch coming.
“If people think they can get out of the market and hold their money in cash until prices come back down, they need to look back to 1987. US valuations entered 2015 higher than they were before the crash.”
This cautious outlook extends to the UK, where Stammers says there are a smattering of macroeconomic bear traps lying in wait, and holds a weighting at 60% of the benchmark.
But while he significantly cut his small-cap weighting ahead of the general election, Stammers sees domestic equities as fertile ground and is comfortable holding positions in the Franklin UK Smaller Companies and Liontrust Smaller Companies funds.
“We like UK small caps because they tend to be domestically-geared,” he says. “There is a huge dichotomy in the UK market between the FTSE 100 and smaller companies. While we are not keen on the UK economy as a whole, in comparison to most places it is in good nick, and small caps are benefiting from that.
“We have pulled the UK small-cap positions back by about 50% in the past few months as part of our wider de-risking strategy, but we still see opportunities there.”
For a company that categorically “does not like bonds”, a medium-risk fixed income allocation of 26.9% in the European Wealth Sterling Bond Fund makes for interesting reading.
“Our fixed income pot represents investments for our low-risk clients,” Stammers says. “Rather than trying to make as much money as we can, we look at it as return ‘of’ capital as opposed to return ‘on’ capital.”
This reticence is exacerbated by the looming prospect of a US interest rate rise along with concerns over market liquidity.
Bond bombshell
But, while some are opting to navigate the low-yield environment currently plaguing bond markets by moving into high-yield investments, Morton and Stammers believe this is the area that will be rocked hardest.
“The yields available on what used to be called ‘junk bonds’ are ridiculously low,” says Morton. “You are getting around 4% on something that is very risky. It is just madness.”
“The interest rate changes we are going to see over the next six months are going to cause a storm in government bond markets,” adds Stammers. “It is like running along the motorway to pick up coins.”
However, it is not just in the bond markets where the impact will be felt.
“People forget there is a link between the bond and equity markets,” Stammers says. “This will be seen to the biggest extent in emerging markets, particularly Asia, where a lot of companies finance themselves by issuing high-yield bonds.
“As interest rates go up and bond market liquidity dries up, no one will be able to buy these high-yield bonds, and there is going to be a real problem in terms of company financing.”
Back to equities, while European Wealth “loves Europe” it is concerned about earnings expectations, and are warm on the Japanese “currency exchange” story, as investors with a 10-year view the regions they are most keen on are the ones with long-term growth prospects.
