Morningstar warns over highly correlated markets

Dan Kemp, chief investment officer, Europe, Middle East and Africa, for Morningstar Investment Management, said this time 10 years ago was in some ways quite similar to now.

"We'd come off the back of a very long run-up in asset prices. The economy seemed to be doing very well and there were certain parts of the market doing better than ours, but there was not a lot of value - so there are some similar characteristics," he said.

While Mr Kemp said there were none of the "obviously visible" bubbles that characterised the markets in 2007, he warned there were enough "similarities" to signal to investors to pay more attention to what they are investing in.

In a market update from Morningstar, Mr Kemp also said investors should be wary of the correlation that occurred ten years ago, when everything seemed to be so overvalued that asset classes and sectors all moved in the same direction - downwards.

It is really important to remember we may have similar declines in the future. The markets do go up and down. Dan Kemp

He explained: "Whether you were invested in UK equities, US equities, emerging market equities, you'd have seen very significant falls and incredible returns from the bottom.

"So when we are in a situation as we are now, and prices look high and not many assets appear to offer good value, then it is really important to remember we may have similar declines in the future. The markets do go up and down."

If the worst should happened, long-term investors will have learned from the last crash that investing from a low point will have seen a considerable return "if you are able to invest when everyone else is scared", he said.

But he added the important thing was to "look for good opportunities, look for unpopular assets, rather than simply going after the most trendy investment".

An "untrendy" investment not experiencing overblown valuations is US financials, according to Eugene Philalithis, portfolio manager for Fidelity's Multi-Asset Income fund.

He commented: "In the US, equity investors are now poised to benefit from the repair work that has been undertaken since the financial crisis."

According to Moody’s Investor Service, most US banks’ planned dividends and share buybacks will now exceed 100 per cent of trailing 12 month net income over the next year.

Citigroup, for example, will pay out 23 per cent of its trailing 12 month net income in dividends, and 100 per cent in planned share buybacks.

Mr Philalithis added: "Financial equities should therefore deliver a good income story for investors. At the same time, the capital side will remain well supported, with share buybacks, relatively low valuations and the potential for rising dividends all helping to limit downside risk."

Rising volatility and tight valuations in the fixed income market are also signalling to some managers that risk needs to be taken off the table in credit portfolios.

Earlier this month, Jorgen Kjaersgaard, portfolio manager of the AB European Income Portfolio, warned there could be rising volatility in bond prices, and suggested investors should "consider dialling down duration in Europe" in particular.

When it comes to valuations, he advised: "Consider taking an overweight position in European financials.

"Many European banks have significantly deleveraged their balance sheets, improved asset quality and would likely benefit from potentially higher interest rates and a steeper yield curve in Europe.

"We favour the Additional Tier 1 bonds of the most recapitalised banks where fundamentals are strong and valuations still look attractive."

He said although valuations in European credit have "become less compelling overall", the team still saw "pockets of opportunity", so it would pay to be selective.

He explained: "These include bonds issued by select European capital goods companies which still offer an attractive yield—while the underlying businesses are poised to benefit from Europe’s better growth momentum."

simoney.kyriakou@ft.com