Investment outlook & strategy update - 19 February 2013
Investing is a counterintuitive exercise. Things that seem obvious are typically anything but, or at least waging money on their outcome is rarely profitable – the seemingly certain scenario is priced in and the risk of an alternative outcome underpriced. Future investment returns will generally be low when starting point valuations are high, yet it will be under circumstances that look and feel rosy that such commentators will argue high valuations are sustainable. Similarly, the greatest returns are generally made when the outlook seems most dreadful and the thought of putting one’s hard-earned cash into the market is most gut-wrenching.
Research touched upon in a recent speech by Federal Reserve Board of Governors member, Jeremy Stein, highlights the difference between “Expectations of Returns” and “Expected Returns” (Greenwood and Shleifer (2012)). The authors find a strong correlation between what investors say they expect stock markets to deliver in terms of future returns and model-based expected returns – only the correlation is negative. In other words, when investor expectations of returns are high, subsequent returns are generally low. These expectations tend to be formed by extrapolating recent returns and are the explanation why the market sometimes trades on lofty valuations. Investor expectations are also positively correlated with mutual fund flows.
Global view - 31 January 2013
Equity markets have enjoyed a strong run in recent months, buoyed by supportive central bank policy, signs of recovery in China and the avoidance of the worst of the US fiscal cliff. Spreads on Italian and Spanish sovereign debt have contracted further. Japan has also recently joined the party, as the election of Prime Minister Shinzo Abe lifted expectations for a more aggressive policy stance. This month, a fiscal stimulus package worth 2% of GDP was outlined and the Bank of Japan announced a long-term inflation target of 2% (although the scale of proposed asset purchases was a mild disappointment). Ever since an LDP election victory seemed likely, the yen has weakened markedly and the Nikkei index moved sharply higher.
The medium-term valuation case favours equities over fixed income assets. Having raised equity exposure moderately in November in the Ashburton Multi Asset Fund range, the current stance on global equities is a slight overweight. Regionally, the current preference is for Europe and emerging Asia, a neutral weighting in Japan (on a hedged currency basis) and an underweight stance in the US.
While we expect equities to perform reasonably well over a one-year horizon and beyond, markets are likely to remain prone to swings in sentiment. In our view, the risk of a near-term correction has risen somewhat: sentiment has become more buoyant and it has become consensus to favour equities, meanwhile the US economic surprise index looks to be rolling over. The US House has voted to suspend the debt ceiling limit until May but negotiations over impending spending cuts (March) may precipitate a bout of nervousness. We do not rule out another rise in European tensions at some point this year or an increase in geopolitical concerns. Within global bond markets, we continue to overweight corporate and selected EM bonds over developed market government bonds or cash.
Global view - 23 October 2012
Equity markets rallied strongly over the last quarter, buoyed by central bank action around the globe. The ECB’s abrupt policy shift is significant in that it greatly reduces the risk of a euro zone break-up, something that was looking an increasing possibility in the summer as Spanish bond yields spiked upwards and peripheral bank stock prices tumbled. While we welcome the ECB’s policy shift, it will not be plain sailing in the region for reasons we detail below. We believe Europe will only emerge from recession very slowly. Even so, given valuations in the region we believe a neutral weighting in Europe is now warranted.
Growth forecasts for China continue to be lowered by economists as softer data persisted into the third quarter. Our expectation of a turnaround in growth in the second half of this year has been frustrated by a moderate policy response. As such, we postpone our expectation for Chinese growth acceleration into late 2012/2013. While risks remain, and we acknowledge that there will be a Non-Performing Loan cycle, at this stage we think most of the bad news in China is reflected in sentiment. The US continues to post modest growth, supported by a gradual domestic recovery in areas such as housing, credit and the labour market, while the industrial sector has slowed lately. The looming fiscal cliff is a near-term risk and some additional fiscal tightening seems likely in 2013. However, we believe moderate US growth will continue next year.
Overall, we expect a difficult global economic backdrop to persist. Financial markets are likely to remain volatile and subject to political influence and shifts in sentiment. We remain Neutral on equities at this point in time. We continue to be overweight in corporate and selected emerging markets bonds rather than developed market government bonds or cash.
Global view - 10 July 2012
The optimism that permeated financial markets in March rapidly vanished during the second quarter. The sources of renewed concern are not new and have dominated sentiment periodically of late: ongoing worries about European sovereign debt and the region’s banking system; fears of a sharp slowdown in China and concerns over the durability of US growth.
Our central view is that Chinese growth will pick-up in the second half of the year in response to incremental policy stimulus. We also believe a moderate US recovery is sustainable, in spite of some weaker recent data, although the looming fiscal cliff poses a risk that will require an improved policy response on last year’s debt ceiling debacle. The decline in the oil price is helpful for prospective US growth.
However, there is little hope of a resolution to the European debt crisis anytime soon given Germany’s opposition to large-scale debt mutualisation or monetisation. Reflecting these macro concerns, we expect the investment environment to remain challenging. Nevertheless, we remain Neutral on equities as valuations are depressed; and Overweight corporate and selective EM bonds relative to developed market government bonds, where the current level of yields suggests negative prospective real returns.
Strategy Update: Climbing the wall of worry - 12 March 2012
Financial markets have been climbing a wall of worry since the escalation of fears in late 2011. At that time, there was widespread concern over an implosion of Europe’s sovereign debt markets and wider financial system, a hard landing in China and a double-dip recession in the US. Since then, things have turned out more or less as one might have hoped. US economic data has been stronger than expected, Chinese growth is slowing but not collapsing and a Greek debt restructuring has been digested by market participants as spreads on Italian and Spanish bonds have narrowed, indicating receding fear of European financial collapse.
Strategy Update - Easy does it - 09 February 2012
It has been a good start to the year for risky assets. Globally, equities and corporate bonds have rallied strongly (up 5% and 2.8% respectively in US dollar terms in January), extending gains made in December. Emerging markets have been big winners, with most equity markets and many currencies posting large returns.
There have been several catalysts behind the moves. (1) The ECB’s 3-year bank loans in December has significantly eased financial conditions in Europe; (2) similarly, the Fed has indicated extremely loose monetary policy for a prolonged period; (3) global economic data has surprised to the upside in recent weeks, even in Europe; and (4) investors were generally positioned very defensively in the fourth quarter of 2011, in fear of a calamity in Europe and a hard landing in China. Suddenly, investors are no longer peering over the edge into the abyss, but instead anticipating a stabilisation in global economic conditions and a recovery later in 2012.
Europe has been the epicentre of recent worries and so it is right to provide an update on our thoughts regarding recent developments.
Strategy Update - Money Market Funds 23 January 2012
We believe investors in money market funds are typically looking for an alternative to cash or short-term bank deposits and expect negligible capital risk. At Ashburton, we therefore remain extremely risk averse in the management of our Money Market Funds so that our clients should never have a sleepless night worrying about the safety of their investment; our number one priority remains ‘capital preservation’.
With default concerns surrounding Greece, contagion spread last year to the larger peripheral countries such as Spain and Italy which saw declining values on their bonds. The European financial sector was hit particularly hard given the extensive holdings of Greek, Italian and Spanish government bonds and on 29 November 2011, S&P cut their long-term ratings for fifteen major banks.
Strategy Update - 24 November 2011
In recent months, we have held long-dated UK and German government bond exposure as a hedge to holdings in risky assets. Our view was that these assets would do well in a negative growth shock or a worsening financial crisis. This has proven the case and these assets have provided a useful offset to losses on equity holdings.
However, at current yields UK and German bonds are likely to deliver poor medium-term returns and we have closed out exposure as a result. The proceeds will be held in short-dated treasury bills in the US, UK and Germany for the time being.
Strategy Update - 15 July 2011
Leaning towards caution
Our previous Strategy Update on 13 June expressed a bullish view towards risk assets based on an alleviation of growth concerns over the coming months.
Our baseline view has not changed dramatically, but a new twist has been the recent contagion to Italian sovereign debt which, in our view, has made the investment backdrop riskier. Accordingly, we again scaled back equity exposure early this week.....
Strategy Update - 13 June 2011
The world economy has slowed. The critical question facing investors now is whether or not the slowdown is temporary. The answer will have important ramifications for returns across all asset classes over the coming months.
Ashburton’s view is that the slowdown is likely to be temporary. If correct, the recent weakness in equities is a buying opportunity and exposure to government bonds should be reduced. Our reasoning is as follows...
Strategy Update - 20 April 2011
Plus ça change...
There has been significant news that has dominated the headlines since our previous strategy update (7 February 2011) but nothing that has materially changed our medium-term view of the world from a global investment standpoint.
Japan's twin natural and nuclear disasters, the outbreak of civil war in Libya, fears over a US government shutdown, a rise in European interest rates and, most recently, S&P's warning of a ratings downgrade for US debt are events that have all occurred in the space of two months.
Strategy Update - 07 February 2011
Beneath the Surface
A detached observer looking at a global equity index would see little remarkable in January's continuation of recent gains since late August, the MSCI AC World Index rising 1.4% on the month.
But the beneath the surface there has been significant rotation…
Strategy Update - 08 December 2010
Recent market anxieties have had a familiar tone: another European sovereign debt crisis (first Greece, now Ireland), concerns over Chinese policy tightening and an escalation in tensions on the Korean peninsula.
The question remains then, will macro events derail the positive bottom-up story?
Strategy Update - 15 September 2010
The past three to four months have seen an escalation in fear regarding the economic outlook. Recent disappointing US economic data, stock market weakness since April, falling bond yields and increasingly bearish commentary would suggest renewed recession and deflation are close at hand.
We are sceptical, however, of the ability of market commentators to forecast the future with much accuracy.
Strategy Update - 27 May 2010
In a very short space of time, world stock markets have suffered a bout of significant volatility and their worst correction since the lows of March last year.
As these recent market declines have made abundantly clear, the world is not free of risk. An array of concerns has knocked investor sentiment: contagion from the European sovereign debt crisis to the banking system and global growth, fears of a Chinese property crash, increasing financial regulation and now escalating political tensions in Korea…
Strategy Update - 29 April 2010
Financial market sentiment has turned quickly with an escalation in the Greek public debt crisis. We outline our current thoughts below:
• Corporate profits are recovering strongly, but market risks remain as highlighted by the Greek crisis contagion.
• The Greek debt crisis has reached a critical point. We expect an imminent EU/IMF bail-out will bring relief to markets on a short-term basis, but suspect the challenges Greece faces will be a multi-year problem. A failure of EU authorities to provide funding within the coming few weeks would make us much more concerned, however.
Strategy Update - 26 January 2010
Adding exposure to Japan
Early in the year we increased the equity weighting of Japan relative to other regions within our Multi Asset and Asset Management Funds.
There are several reasons for the switch:
Strategy Update - 03 November 2009
Is the 'sweet spot' turning sour?
Financial markets have enjoyed what has been dubbed the 'sweet spot' in recent months – a recovery in economic growth coinciding with extremely loose monetary policy. This, in part, explains why recently risky assets such as equities, corporate bonds and commodities have risen at the same time as government bonds.
Strategy Update - 28 August 2009
Taking some risk off the table
Across our Multi Asset Funds we have decided to take some equity risk off the table (25/08/09). The equity weighting in the Asset Management Funds, for example, has been reduced from 45% (close to the maximum permitted) to 30%.....
Strategy Update - 02 June 2009
Over the course of April and May we significantly increased our equity weightings across the Multi Asset Funds.
While the current economic backdrop remains weak, the evidence increasingly points towards a global recovery in the second half of 2009. Among the more important developments, credit market conditions have continued to ease and there are signs of stabilisation in US consumer spending and home sales....
Strategy Update - 9 April 2009
Update on Money Market Funds
Since our last update we have seen some tentative signs that the credit markets are easing, albeit very slightly. Credit spreads (i.e. the premium that corporate borrowers have to pay relative to government bonds and treasury bills) have tightened significantly...
Strategy Update - 30 March 2009
"Amidst the gloom comes a glimmer of hope"
If not quite optimism yet, a sense of relief is in the air. Global equities are up 23% from the lows in early March and fears that were prominent less than a month ago - of bank nationalisations, sovereign government defaults and contagion spreading from economic weakness in Eastern Europe - have quickly dissipated...
Strategy Update - 17 February 2009
"Extreme pessimism creates opportunities"
The turning of the calendar year has provided little relief to investors. Recent economic and corporate data has only confirmed the severity of the current recession. No region has been left unscathed, as weakness in industrial production and trade data globally suggests. Financial markets remain plagued by fear and uncertainty...
Equity Strategy Update - 26 November 2008
"History doesn't repeat itself, but it does rhyme", said the estimable Mark Twain. The problem we face in trying to navigate today's bear market is, which history? The S&P 500 index has fallen nearly 50% in the last 12 months, and there are only a couple of historical precedents for this decline. The most recent is the bear market that ran between 1973-74, where markets fell 48% in 21 months, but then rallied hard, gaining 70% in the next 2 years...
Strategy Update - 13 October 2008
Congress finally got round to passing the much-changed bank rescue plan bill and markets plunged anyway. Not for the first time the US authorities were in the uncomfortable position of playing catch-up with the crisis and the markets. Ballooning credit spreads and rumours of multiple bank failures spread panic through the markets...
Strategy Update - 30 September 2008
On Monday night, US politicians voted to reject the Paulson plan to rescue the American banking system. This was definitely not in the script and resulted in one of the sharpest stock market one-day falls ever registered on Wall Street...
Strategy Update - 19 September 2008
In our last strategy note we outlined two likely scenarios, either America and China would lead the global economy into a recovery phase or more needed to be done to shore up the crumbling financial system (cuts in interest rates, more injections of liquidity and nationalisations). In the first scenario, equities would edge gradually higher. In the second, equity markets would plunge to new lows before rebounding strongly. At the time we favoured the first scenario, but only just. Given the uncertainty and the downside risks associated with scenario two, we decided to trim back our equity weightings. It's just as well that we did...
China an update - Strategy Update - 10 September 2008
Following our last note on China and India in late June, we thought we would make a few brief comments on market developments since then. We will focus on China, as China is key to Asian stock market performance. One thing hasn't changed, unfortunately, and that is market direction: down...