Experts from Hassium Asset Management reveal their market summary and outlook as of February 24th 2012
Markets have made a strong start +8.9 per cent YTD but we see the risk-on-trade as a mini-bubble. Investors have taken some comfort from better than expected US economic data, an accommodating Federal Reserve in the run up to the US Presidential election, and the perceived success of the ECB’s LTRO scheme curtailing the funding risks for European banks. Events in Greece seem to be playing out and recent data in China is supportive of a soft rather than hard landing. The rally is a positive sign but in our view markets have rallied too much too quickly.
Fundamentally we do see improving corporate earnings, fair equity valuations and low interest rates all supporting global equity markets and the longer term global recovery. We still maintain that a global recession will be avoided and that the US and Eurozone leaders will eventually get policy right. We also maintain that the US and emerging markets will continue to grow albeit slower than the markets had initially priced.
However, we continue to expect a recession in Europe with further credit rating downgrades, bank nationalisations and on-going austerity measures implemented. Greece continues to be plagued with problems. We anticipate a further Eurozone interest rate cut in the coming months although this has already been discounted by the capital markets. That being said European corporates ex-financials are in a healthy financial state, equity valuations look attractive, and the longer term EUR/USD downtrend will help support EU economic growth. In the US things are more upbeat reflected in recent US GDP numbers, positive corporate earnings, unemployment declining to 8.3 per cent combined with improving housing and manufacturing data. We remain mindful of further QE as well as upcoming political elections later this year in the US, France and Russia and a leadership change in China.
Commodities and emerging markets have performed particularly well despite geopolitical risk, inflation and asset price bubbles. Emerging market equity valuations have moderated and inflationary pressures seem to be diminishing. We have gradually been increasing our allocation to emerging markets, crude oil, base metals and soft commodities. We are less positive gold which we see as being in bubble territory.
In currencies we have seen on-going USD strength with a corresponding decline in commodity prices. The Euro remains volatile as events in the Eurozone play out and the USD continues to live up to its safe haven status. The recent move in the Euro has been driven by hopes around a Greek bailout and comments from Bernanke that US interest rates will remain on hold until late 2014. On a PPP basis USD still remains undervalued against most major currencies, despite the LTRO scheme and progress in Europe. The CHF and JPY remain firmly in bubble territory.
At current market levels we would not be allocating new money in a meaningful way to riskier assets. Macro concerns continue to dominate with short term risks skewed to the downside. Our sense is to watch geopolitical, economic and market events very closely over the coming weeks and months and to look for another suitable entry point once we see real progress around the Eurozone debt crisis. The rally is a positive sign and start to the year but now looks overdone.
Updated Investment Strategy
Over the long term the primary focus for investors should be wealth preservation. Investors should stay focused on term noise around events in Greece. It’s important for investors to understand that volatility and risk will likely increase going forward. Return expectations need to moderate. Risk, diversification and liquidity are all key considerations.
(1) At least 80 per cent of your portfolio should be liquid. Not because we think the world is falling apart but rather because there will be some amazing fundamental buying opportunities for investors once all the dust around events in Europe settles.
(2) Keep 30 per cent in cash for potential buying opportunities. We are also mindful that in a ‘Black Swan’ environment all major asset classes become highly correlated and cash becomes the only real diversifier to market risk. Traditional asset allocation and portfolio diversification goes out of the window. The only asset class not impacted is cash. All cash like investments should be in your base currency; so called carry trades in non-reference currencies are speculative in nature and best avoided.
(3) Bonds remain expensive. Don’t own Government bonds with more than five years in maturity. We would recommend you stick to UK Gilts, German Bunds and US Treasuries depending on your base currency. We would also recommend an exposure to high investment grade short dated corporate bonds which offer a yield pick-up over cash and government bonds. Above all avoid taking credit risk and interest rate risk in this environment and chasing marginal yield could prove costly over the long term.
(4) Don’t forget Large Cap Global Equities. We remain short term cautious about equities despite the recent rally. Longer term we are encouraged by fair equity valuations, strong corporate balance sheets, along with recent corporate earnings numbers and guidance, and low interest rates. Dividend yield is a meaningful component of total returns. We also see signs of central banks and sovereign wealth funds gradually selling US Treasuries and reallocating to global equities.
(5) Commodities and emerging market exposure are key and have significantly outperformed in the first part of 2012. We have become more constructive oil, base metals, and agricultural commodities along with broader emerging markets, with the exception of China. The weaker USD and risk-on-trade by investors has seen both commodities and emerging markets rally, but too much has happened too quickly. We now advise investors to wait for a more suitable entry point.
(6) Gold is a cash alternative. We would recommend limiting your exposure. Gold remains in bubble territory and any new money allocated tends to be speculative in nature. We would not be increasing allocations in the current market environment. When worries over global growth and events around Europe dissipate investors will quickly sell gold and reallocate to riskier assets. In a ‘Black Swan’ environment investors will sell gold and reallocate to cash as we saw in August and September 2011. As an alternative to gold look at silver and platinum.
(7) Limit your exposure to banks and financials irrespective of asset class. Banks have been deleveraging since 2008 but the sector still looks fragile and is vulnerable to geopolitical events around the European sovereign debt crisis as seen by the raft of recent bank downgrades and profit warnings. We expect further bank downgrades in the coming months.
(8) Keep your exposure to hedge funds and private equity below 10 per cent. Exposure is a leveraged play on the global markets, costs are excessive, and liquidity remains almost non-existent. Understand the qualitative and quantitative risks you are exposed too and be sensitive to redemption periods and gates.
(9) Selective real-estate is starting to look interesting. Investors should stick to high quality units in the best locations. We remain mindful of illiquidity but see selective opportunities in an environment where bank lending remains scarce.
(10) Total fees should be below 0.8 per cent. This includes management fee charges, execution costs, custody fee charges and any retrocessions or rebates which should be returned to you as the client. Ask questions, understand charges, and reallocate where charges have become excessive. Remember fee leakage over the long term equates to wealth destruction.
Three and a half years have passed since the onset of the financial and economic crisis of 2008. Many investors feel that since then not much seems to have changed. We believe amongst all the volatility and uncertainty some attractive investment opportunities will present themselves. The key for investors is not to panic or over react to geopolitical events. The financial media and markets have a habit of becoming too bullish and or too bearish. The environment may not be great at the moment but there are some positive signs that issues will get resolved and markets will improve over the longer term.