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“Exceptional standards … so you can enjoy everything without having to worry about anything.” This is the reassurance that Club Med gives to would-be holidaymakers before they part with roughly £2,000 ($3,000) for an all-inclusive week in one of its mid-market southern European hot spots.
If only the governments of Greece, Portugal and Spain could offer such a guarantee to foreign investors before asking them to part with considerably more to buy sovereign bonds. These three countries, now ironically dubbed “Club Med” by pallid UK credit analysts, have been putting the wind up equity and debt markets for months – while concerns grow over their ability to repay massive borrowings.
Fears of default on Greek sovereign debt pushed the yields on the country’s bonds up to nearly 6 per cent last month, forcing the government to impose austerity measures to cut the country’s budget deficit from 12.7 per cent of GDP to 2.8 per cent.
For wealth managers, the question is whether a bond market meltdown will burn their equity investor clients, who now look a little overexposed.
According to Scorpio Partnership’s twice-yearly asset-allocation survey – of 33 private banks, private-client asset managers and family offices – allocations to equities in a “balanced” portfolio rose from 37 per cent in the first quarter to 49 per cent at the end of the last. Four out of 10 wealth managers said they would increase their weighting to equities this year. Many may now wish they had stayed at home.
Yves Bonzon, chief investment officer at Pictet Private Bank, says: “The issues of Greece and contagion to other places came earlier than expected. The sovereign debt issue is something everyone has on their agenda.”
Ted Scott of F&C Investments tells it more plainly: “If Greece did default, then equities would fall sharply.” An EU compromise could ease the pressure on Greece, Portugal and Spain, but he warns the contagion could spread to UK gilts.
“A further deterioration of the sovereign debt issue in the eurozone would create increased nervousness over the status of the UK’s debt,” Scott says, pointing out that credit default swaps – insurance contracts against bond default – have become more expensive for gilts than for Vodafone or BP bonds.
Some equity analysts sound as if they have cancelled their European excursions and settled for a day at the zoo. “The sovereign debt crisis is the elephant in the room as far as the equity market is concerned,” claims Scott. “If a major economy were to default, it would spell the end of the bull market.”
Bonzon appears no more enthusiastic about an Asian investment safari. “Investors’ portfolios are probably still too much tilted on a six- to nine-month view to the Chinese elephant in the room: Chinese equities and emerging markets. That trade is clearly at risk because of a falling euro and rising dollar.”
Rob Pemberton of HFM Columbus finds some of the tourist-trap destinations all too similar: “Today’s ‘Sinophiles’ were quite possibly ‘Japanophiles’ back in 1990 – and it is not that long ago that we were lauding the economic success of Spain, Ireland and Iceland.” Recent measures by the Chinese authorities to tighten monetary policy suggest the comparison is being taken seriously.
Bonzon expects changing conditions in China will result in a sectoral shift away from commodities and resources, as well as ongoing pressure on banking.
But when the debt crisis blows over, he believes conditions will be right for an earnings-led recovery in other equity sectors. “On the corporate side, profits look on track for 20-30 per cent growth this year …It might be a frustrating 6-8 months, but I think we are in for double-digit equity returns [this year].”
Scott agrees. “I think roughly 13 times earnings is fair value for the market … but there is upside provided by further upgrades in profit forecasts … profits have come in above expectations for three successive quarters.”
Jeff Keen, head of asset allocation at JO Hambro Investment Management, believes multinational large caps can provide these profits streams on low valuations right now. “Large-cap companies featuring stable growth look attractive with their premium having shrunk to virtually nothing.”
Bonzon is therefore positioning for the medium term with “less emerging risk and more blue chip”, citing the healthy Swiss market.
But before checking into a blue-chip fund, clients should ensure they get the views they paid for: Scorpio found allocations to high-margin in-house equity funds, rather than external funds, rose from 22 per cent to 40 per cent last year. To get away from it all, you will want to go past your own front door.