With equity markets hitting record highs, investors should keep an eye on debt as a first indicator of potential storm clouds.

Investors are at risk of becoming complacent thanks to quantitative easing and low interest rates driving people to take on more risk in their ‘desperate search for yield’, Thesis Asset Management’s Michael Lally has said.
Lally believes that there is a ‘spectre of defaults’ in either sovereign or banking debt on the horizon, particularly in those financially less disciplined or politically unstable European countries. “It is difficult to envisage how they [defaults] can be avoided. The only difference is that the word default will not be used, preferring instead such less alarming terms as ‘debt rescheduling’ or ‘debt restructuring’. “
Some of the classic indicators of a market about to correct are now visible, according to Lally, i.e. a “broad acceptance amongst the participants that, although prices might be looking a little stretched, not to worry because the momentum is strong, the economic backdrop is supportive and the alternatives are even more expensive or unpalatable.”
“Market liquidity may also be tight, so the likes of institutional investors and retail fund managers, who have a constant flow of new funds to invest, effectively become distressed buyers. For most institutional fund managers (and many others) it is largely this philosophy which dictates that the avoidance of underperforming your benchmarks and peers is so critical a centrepiece of strategy that taking more drastic alternatives (however reasonable) to preserve capital are seen as just too risky.”
However, on a positive note Lally says there will also be opportunities this year, “Exactly the same factors which help fuel excessive valuations will, thanks to the proverbial herd instinct, provide the opportunities when tactical switching, sector rotation or enforced reality checks, kick in.”