OVER the past month markets have been rattled by a resurgence in geopolitical risk as well as one off events such as speculation over Portugal’s Banco Espirito Santo’s credit worthiness and the Fed’s commentary on equity valuations, writes Samantha Dolby, and investment manager at Brewin Dolphin in Newcastle.

Events like these weaken returns across most asset classes and whilst the nervousness is typically short lived, it serves as a warning sign for investors.

Central Bank liquidity has defined markets since the financial crisis and has suppressed volatility, as measured by the VIX Index, to all-time lows. While this could last for some time, the risks are firmly on the upside.

Geopolitical risk is unpredictable by nature but disruption could broaden, especially given the unrest in Russia & Ukraine and the ongoing diplomatic wrangling’s in East Asia. The lack of market response to events in Ukraine is complacent in many people’s view.

The repercussions of Angela Merkel’s backing of EU sanctions hitting Russia’s defence, energy and financial sectors is yet to be seen.

Economic forecasts have fallen in recent weeks, especially in the US and Europe. In the US, small-cap valuations are described as being stretched. Expectations for interest rate increases in the US and UK have been brought forward as unemployment has continued to decline and inflation has been returning to normal levels since the start of the year. However, Yellen and Carney show determination to keep the emergency interest rate policy in place, reflecting underlying economic problems which are yet to be resolved.

Second quarter US growth figures however suggest the recovery is back on track. The 4% growth figures beat expectations by 0.9 per cent demonstrating the world’s largest economy is picking up speed and the robust jobs data in recent months was not by chance. This indicates the economy has enough momentum to keep bringing down unemployment, adding fuel to the debate about when interest rates will rise. This is also supported by the US central bank reporting it would reduce its monthly asset purchases (Quantative Easing Programme) by a further $10bn, to $25bn, maintaining the highly accommodative policy stance.

This also comes at a time when overseas investors are selling out of UK gilts, and if the trend is sustained, would be a concern for the market. The future uncertainty of an independent Scotland and profit taking before an interest rate rise are popular theories. According to a recent study, Scottish independence in September could have a modestly negative impact on the UK stock market and significant consequences for key British sectors. Given the UK’s tariff free trading with EU member states, UK trade is under threat should the EU not admit an independent Scotland.

Despite a disappointing start to 2014, the global economy remains robust on the whole.

The current global geopolitical events could bring some volatility to markets. The UK economy is trading around its pre-crisis peak and prior to the strong US growth announced last week, was growing faster than the other G7 nations. With the FTSE considered overvalued, some top slicing would be welcomed, bringing prices and earnings more into line with each other.

Samantha Dolby

samantha.dolby@brewin.co.uk

Samantha Dolby is an Investment Manager at Brewin Dolphin and offers advice on a wide range of financial services to private clients, trusts, charities and pension funds.

Past performance is not an indication of future performance. The value of any investment and any income can fall and you may get back less than you invested. No investment is suitable for all people and should you have any doubts you should consult an authorised financial adviser.

The information contained in this article has been taken from public sources and is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents.