There are serious concerns about government bonds, and investors should tread carefully, Andrew Milligan, Standard Life Investments’ head of global strategy, has warned.
Despite equity markets appearing healthier, with new highs established on strong corporate earnings, he said that earnings growth needed to expand into 2015 to allow the rally to continue.
He said that for those investors seeking fixed-income returns from the eurozone, Europe’s government debt market was of “particular concern” because of a combination of record low yields and weak growth.
Writing in the fund manager’s 23-page Global Outlook, fourth quarter 2014, Mr Milligan warned of the potential for a “sharp sell-off” in European sovereign bonds following “even small changes” in policy making once quantitative easing is fully priced into debt markets.
Despite this, the fund manager currently remains heavy in European debt because of perceived support from disinflationary measures.
He said: “Prospects for equity markets are of less concern, with the fund manager remaining heavy in most developed markets, particularly the US, seeing better prospects for earnings growth there.”
Advisers could be encouraging investors back into the stock market. Mr Milligan said: “These are not seen as expensive as their debt counterparts. Traditional end-of-cycle pressures, for example, excessive corporate activity such as mergers and acquisitions, are not seen.
“The necessary conditions continue to fall into place for further global M&A, business investment and share buybacks, which would support the long-term uptrend in risk assets.”
However, Mr Milligan warned: “Sharp increases in borrowing or energy costs, wages growth or tax changes should be examined carefully for any adverse impact on corporate margins.”
Adviser view
Jason Hollands managing director, business development and communications for London-based Tilney Bestinvest, agreed that caution was required on valuations of bonds markets.
He said: “There are few bargains to be had, stemming from the supply of easy money in the past few years. But this has led to price distortions, particularly in the government bond markets. This has sent investors off to more high-risk assets seeking higher yields.
“The US is the place where you are seeing good underlying growth and corporate profitability. Against this there is relative value to be found in emerging markets, which now look cheap compared with developed ones. However, if there is a sell-off they will not be immune.
“European equity valuations look interesting, following the sell-off that came after the recent European Central Bank meeting which investors had expected to yield a more aggressive stance. We would expect to see more bold moves by the ECB in 2015.”
