European sovereign debt contagion, lacklustre growth in developed economies and inflation in the East are all weakening investor sentiment. But what is the real threat to your clients’ investment portfolios?

Being too defensive

Tom Becket, CIO of PSigma Investment Management

Given we are presently suffering a huge bull market in fear and everyone is very long of pessimism, I am going to take the opposite tack to most commentators. There is a risk that if the world is not in so bad a state as most are claiming then asset markets could perform very well over the next 12 months.

Current valuations of “quality” equities and high yield bonds are attractive and in the absence of a material economic growth shock, both could make decent headway despite all of the gloom lingering over financial markets.

The greatest risk, as far-fetched as it seems now, is that if you are too defensive then you might not keep up with the strong return expectations of your clients after a period of material wealth destruction. Let us hope such worries become more relevant as this miserable year continues and as we move forward.

Europe

Carl Stick, investment manager, Rathbone Income fund

There are clear risks to global economic health that were not being reflected in stock market valuations, coupled with a temptation for investors to seek out returns at any cost. Europe remains a very dark cloud indeed, and we are grinding towards a point where decisions need to be made.

One route would be to write-down the debt of insolvent countries, to give them a chance of some nascent economic recovery, and to lend support to those banks worth saving. The danger here, however, is if the pain within the financial sector becomes too much to bear and liquidity freezes, the impact on equity markets will be extremely difficult to predict.

Shares, such as those in the banking and mining sectors, for example, might therefore look cheap, but investors need to understand on what basis those valuations are made.

Global default

Jeremy Batstone-Carr, chief economist, Charles Stanley

In difficult times such as these we regard it as essential to ask oneself, what is the worst thing that could happen? In our view the worst thing that could happen is global default. Having established that position one should then attempt to see how far away from it we are and whether it is coming closer or receding into the distance.

In our view the threat posed by the doomsday scenario is rising with each day that passes. Private sector debt has passed to governments and now entire countries are at risk, not just the financial system. Austerity measures are slow and gains hard won. Monetisation of debt through ultra-easy and unconventional monetary policy is being pursued but risks a Zimbabwe/Weimar type hyperinflationary event the consequence of competitive currency debasement.

At a time when the world needs strong leadership, politicians and economic authorities are in disarray. Can/will China come to the rescue? We are increasingly doubtful of that country’s capacity and willingness to throw good money after bad.

In such circumstances clinging onto ones capital for grim death should be the central plank of any investors’ strategy.