Investors have had to endure two geopolitical shocks in the space of a year, with US tariffs and conflict in the Middle East causing an amount of turbulence that normally would send them running for cover.
They would not be wrong, with geopolitical risk also being the first concern right now for Chris Clothier, manager of the Capital Gearing trust. But tariffs on trade and the Hormuz crisis aren’t the only reasons to worry.
Another is the bond market itself, where Clothier sees trouble ahead.
“A crisis is brewing in global bond markets,” he said. “We don't know where it will emerge or when, but it feels likely to us that it's going to happen.”
While it might take a decade to pan out, the manager is “very concerned” with the high levels of deficits that developed-market governments are running, which are “unsustainable over the long term”.
For the manager, the “obvious candidates” for a crisis would be the US, the UK, France and Japan.
“If that crisis does emerge, and this is all about debt sustainability, then we would expect long bonds to be very weak, but we would expect that to flow into equity markets as well, because ultimately all risk assets need to be priced off the risk-free assets,” he said.
“So clearly, if global government bond yields are very high, then that will flow to equities.”
The UK's place among his four crisis candidates is that, when it comes to currencies, it is sterling rather than the dollar that worries Clothier more.
“I accept that the dollar is a very unfashionable currency, and we understand and share all of the concerns that people have about the dollar,” he said.
Those concerns include “fiscal unsustainability and a president who's trying to drive a coach and horses through the constitutional arrangements”. But despite that, “it's just that we have a greater level of concern about sterling”.
This is because of the UK's exposure to imported energy costs and policy choices he finds hard to square: “It seems strange that we don't exploit the fossil fuels that are available to us in the North Sea, instead of relying on liquefied natural gas from Qatar, for instance.”
Beyond energy, Clothier argued the UK lacks the buffers that cushion its peers. The US benefits from the dollar's role as the world's reserve currency, which sustains demand for its assets even as its own deficit grows. France's fiscal position is arguably weaker than the UK's, he said, but it has the backing of the European Central Bank.
The UK, he said, has neither advantage, leaving a low-growth, supply-constrained economy exposed on both the fiscal and currency fronts.
That same bond-market stress, Clothier says, is already showing up somewhere else: hyperscalers borrowing heavily to fund the AI data centre boom.
Data centres are being built with heavily borrowed money and it's unclear to Clothier how much of the repayment risk sits with the hyperscalers themselves. If they're on the hook for the lease payments, weak AI revenues could become a drag on their earnings; if they're not, it's the data centre operators who took on that debt who could end up distressed, with knock-on effects for the corporate bond market.
“It is well known that hyperscaler free cashflows are turning negative. What is more interesting are the additional obligations they are taking on. For example, in addition to debt of $46bn, Microsoft’s lease liabilities increased from $62bn a year ago to $85bn today,” he noted.
“But what is more striking is that the leases that they have committed to but haven’t started yet have increased from around $100bn a year ago to $197bn today.”
All this translates at portfolio level as equities making up 14% of Capital Gearing and risk assets, including infrastructure, at 23% – both near the bottom of its historical range. The trust topped out at just under 50% in risk assets after the pandemic.
Around half of the trust's assets sit in inflation-linked bonds, split between the US and UK and held largely unhedged. The balance between the two has been maintained close to even but recently shifted towards US TIPS, Clothier said, because of his concerns around sterling.
But the split wasn't always even – for most of the past decade, Capital Gearing held far more of its inflation-linked exposure in US TIPS than UK linkers, because pension funds' liability-driven investing strategies had driven the price of UK index-linked gilts to levels Clothier considered unattractive, as defined benefit schemes were pushed into them during the quantitative easing era.
That changed with the gilt crisis, when yields on UK linkers converged with their US equivalents almost overnight. Since then, Clothier has kept the two roughly equally weighted, tilting only slightly back towards the US, given his sterling concerns.