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Multi-manager’s view: Europe tops the list of potential headwinds

While the jury remains out as to whether we are witnessing the so-called great rotation from bonds to equities, there can be no doubt that equities have the upper hand so far this year.

Certainly, retail sales figures from both sides of the Atlantic suggest that investors have been far keener on equities over the last few months, and it is encouraging that markets have responded accordingly, with many developed world stock markets enjoying their strongest gains in January for many years. However, the more important question is can the rally continue?

Our view is that equities should provide decent real returns over the medium to long term. Valuations are certainly not stretched and corporate balance sheets remain in good shape.

Meanwhile, and this is perhaps understated, the amount of equity out there continues to shrink through a combination of M&A activity, particularly in areas such as UK small caps.

In addition, many larger companies have continued to take advantage of investors’ seemingly insatiable appetite for income by issuing debt at record low levels, while retiring what is in comparison very cheap equity. Call this financial engineering if you like, but to us it seems like just good use of the balance sheet, although we accept that this strategy will not work indefinitely and companies will eventually have to think of other ways of deploying their cash.

While stockmarkets around the world have produced excellent returns since last summer, we would also caution that investors will face many macro headwinds going forward.

Top of this list remains Europe where the situation is admittedly nothing like as dire as on a number of occasions during 2012, although I do not think for one minute that anyone believes that the financial crisis has been resolved.

It certainly has not been in Greece or Cyprus, while in Spain, which is of more relevance to the markets, I don’t suppose the 26 per cent or so unemployed believe that the crisis is over either.

Add to the political uncertainty in Italy and elections in Germany later in the year, plus the political shenanigans which will shortly re-emerge across the pond, and it is clear that investors will have plenty to keep them on their toes over the coming months.

While equities have enjoyed a strong start to the year, the same cannot be said of bondE markets, where both gilts and to a lesser extent investment grade corporate bonds are nursing modest losses so far this year.

High yield, meanwhile, remains in positive territory, although prices have slipped back of late, with investors baulking at record low yields seen in both US and European junk bonds during January.

While we remain underweight bonds, we are slightly more sanguine about these markets than many others.

That said we continue to avoid gilts, which we believe will continue to produce negative real returns for several years to come. However, we do not expect a sharp rise in yields any time soon, as the Bank of England will almost certainly do everything in its power to prevent this.

If our analysis is correct, then both investment grade and, in particular, high yield should continue to produce reasonable returns, as investors continue to search for income. However, we remain convinced that the best returns for these assets are behind them and better opportunities exist elsewhere.

David Hambidge is director of Premier multi-asset funds


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