Tactical positioning

Date: 02 Nov 2011


Experts from investment office Stanhope Capital discuss the equity markets:

The last week in October witnessed a swift ‘melt up’ in equity markets as investors welcomed the Eurozone leaders’ attempts to resolve some of the region’s debt issues. Despite this, we have refrained from adding to equity risk because we expect that markets will start to ‘roll over’ as politics moves centre stage once again. The political environment will continue to be a source of uncertainty for investors in all asset classes.

In the short term, equity markets may give back their October gains and so we are likely to remain conservatively positioned. We have however allocated to a specialist US, short dated, high yield corporate bond fund (ex financials) for many portfolios. This fund should capture the anomaly that we mentioned in the previous bulletin, of an exceptionally attractive yield level. We see this as a safe haven in an environment where, ironically, it has become more difficult to spot credit risk in Governments than in Corporates.

Market moves:

Equity markets rallied across the globe over the fortnight with the S&P 500 up +7.1 per cent, MSCI AC World Index +5.7 per cent, FTSE 100 +4.9 per cent, MSCI Europe +5.4 per cent, Nikkei +1.9 per cent, and MSCI Emerging Markets +7.4 per cent. October saw the S&P rally the most since 1974 as markets welcomed the collective decision making from the Eurozone leaders in their effort to resolve the ongoing sovereign debt crisis.

In fixed income, high yield (below BBB) rallied along with other ‘risk-on’ assets with the US and European markets both returning 4.0 per cent. Investment grade credit (BBB rated or above) also performed, up 1.4 per cent in the US and UK and one per cent in Europe, owing to spread contraction. However the returns were compressed by their sensitivity to interest rate movements which over the period had moved out. Ten year US Treasuries were 17bps wider, equating to a capital loss of 1.4 per cent.

The Dollar Index retreated 2.7 per cent, falling the most against the euro (-3.0 per cent) in the wake of the EU summit resolutions. Emerging market currencies also reversed some of their recent losses with the Brazilian real up 6.1 per cent and the Mexican peso up 3.7 per cent against the US dollar. Gold also advanced 4.4 per cent to end the period at $1743.7 per ounce.

Economic update:

CPI in the UK is a record 5.2 per cent, the financial crisis in Europe is far from resolved and inequality of wealth and income (as measured by the Gini Coefficient) in the US and UK have been steadily increasing since the 1970s. It is against this backdrop that market movements continue to be dictated mainly by macroeconomic events.

The much anticipated two part EU summit was the main political event over the past fortnight. From the summit, European leaders agreed on three broad issues each aimed at attempting to regain the market’s confidence that a solution is in sight. The agreements was that European banks should recapitalise their balance sheets with an estimated ‚Ǩ106 billion aimed at achieving a core tier 1 ratio of nine per cent, a 50 per cent voluntary haircut for Greek government debt holders and a ‚Ǩ1 trillion leveraged EFSF Fund. Following the announcement there was a brief period of euphoria in the markets which resulted in the S&P 500’s greatest monthly rally in nearly 40 years. This was quickly followed by a slow trickle of economists opining that the package was not large enough (perhaps ‚Ǩ3 trillion is needed), that it lacks detail and that once again the EU has managed to buy time. But perhaps the real spanner in the works occurred after the fortnight covered in this report, with the announcement by the Greek Prime Minister George Papandreou that Greece will go to a referendum to see if its people want to accept the Greek bail-out package and resultant austerity measures. The timeline for such a referendum if it occurs will be early next year. Until then, we expect markets to continue to range trade in a highly erratic manner.

There is a two day G20 summit planned for Thursday 3rd November. At this meeting market participants were expecting to hear more details of the EU package and possibly an announcement by China that it would lend “a helping hand”. Papandreou’s announcement will certainly change the tone of this meeting.

The changing market intervention is likely to reduce the appeal of CDS protection. It is clear that authorities are working to ensure that the major “systemic banks” will not default – preventing the need for CDS cover for these banks. In the case of country CDS, those such as Greece that do need to default will be allowed to do so in a way that does not trigger the CDS payments – nullifying the credibility of the contract.

On to regular economic data, the flash estimate manufacturing numbers for the Eurozone showed a weak 47.2, falling from 48.8 in September. This lends weight to comments from the press that the Eurozone will contract in the last quarter of this year.

In the US the situation is rosier with annual CPI at 3.9 per cent in September slightly up from 3.8 per cent last month. However core CPI was a moderate 0.1 per cent and quarter three growth was also a healthy 2.5 per cent annualised. The Federal Reserve Board’s Beige book concludes that there is growth in all 12 regional Federal districts, albeit at a modest rate.

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