Eurozone government bonds don’t offer an adequate compensation given their current risk/reward profile, according to Jupiter Asset Management’s Miles Geldard.
‘We would argue that French, Spanish and Italian bonds are overvalued and their yields seem very low given their risk/reward profile. In Europe, the situation remains very fragile and disinflation still appears to be the order of the day,’ he said.
Sovereign debt currently makes up 7% of long exposure in the JGF Strategic Total Return fund. This is while corporates make up 41% and floating rate notes (25%) make up the two largest fixed income allocations.
Geldard believes the rising rate cycle will result in a volatile period for financial markets. Therefore, reasonable long term equilibrium yields would be some 100-200 basis points higher than current levels to reflect central bank inflation objectives and appropriate risk premia.
‘Central banks will have to be careful not to raise rates too quickly given debt levels remain elevated. As a result, we believe the times call for more caution when it comes to taking on risk,’ he added.Geldard thinks the risk premia are more fairly reflected in areas such as Asian equities and Latin American bonds.
‘Despite the economic slowdown, you can find in Brazil yields on certain bonds that went from 8% to 13% in the space of a few months as a result of the decision by Brazil’s central bank to raise its rates,’ he said.
Moving to Asia, he thinks China has the capacity to avoid a systemic credit crisis. ‘Chinese stocks have looked attractive to us and we have been putting more money to work here because they offer what we believe is very significant value.’
US small caps are overvalued
Looking at situation in the US, Geldard thinks the strength of the country's economic recovery has driven valuations among small-cap stocks to levels that do not truly reflect the value of the businesses.
‘Investors seem more drawn to the exciting future potential being offered by biotech, social media and internet firms than to actual current earnings and cash flows. To our mind, this enthusiasm for such stocks appears unjustified, especially as in some areas there are few barriers to entry,’ he said.
He said his funds are both currently positioned for a reversal in this trend to the benefit of large, cash flow positive, revenue-producing companies.
On the currency side, Geldard thinks both the euro and sterling are overvalued against the US dollar. ‘The British economy may well be in better shape than its European counterparts, but the long term drivers of growth are less robust than the US.’