Wealth and Investment Management Blog

Micro management and macro crisis

Posted on February 24, 2012 by Wealth and Investment Management

Kevin Gardiner, Head of Investment Strategy EMEA

“Move the mouse… up… up… over… more… Click it… CLICK IT!”
Pointy Haired Boss (Dilbert)

Another late-night summit, another inconclusive result. We still don’t know exactly which investors will bear the costs of Greece’s debt forgiveness, or exactly how much they will pay. Anyone with corporate experience can’t help but feel uneasy at the news that the troika are establishing a permanent mission in Athens to micro manage the austerity and reform process: local demoralisation and backlash looms even larger than it did.

Elsewhere, the sad denouement in Syria – and the potential for even more traumatic developments elsewhere in the region – is keeping geopolitical risk on the front pages. In sterling and euro terms, crude oil prices have just hit new nominal records. Meanwhile, with developed stock prices up 10% in 2012 already, and by 20% from their October lows, there is plenty of profit on the table to be taken. You don’t have to look far to find reasons for a setback in developed stocks and in risk assets generally.

The key investment question is: Should we try ourselves to micro manage portfolios with these risks in mind, or focus instead on a bigger picture? Even professional investors have found it difficult to second-guess the twists and turns of capital markets these last few years, and as our behavioural finance team remind us, for private investors in particular, the danger of selling low and buying high looms very large when markets are volatile.

We still believe we should avoid fine tuning, and focus instead on the longer-term view. Because as we see it, the rally is neither surprising nor without foundation. The ultimate fate of Greece may still hang in the balance, but the ECB has been decisive in supporting the banking system, and may have largely insulated it against even a formal default (not that we yet expect one). Economic data have been less fragile than feared on both sides of the Atlantic – witness again the latest IFO (Germany) and CBI (UK) surveys, and the ongoing descent in US weekly unemployment claims. If anything, the US recovery may be taking on a more durable tenor as the housing market at last finds its feet. There is even a silver investment lining to higher oil prices, since they tend to boost corporate profits, at least until they begin to hit consumer spending, of which there are few signs yet (there are more big producers of oil in the major stock markets than there are users of it).

And despite the rally, developed equities – and to a lesser extent, high yield credit – still look inexpensive to us. We have often written about how we think that received wisdom on stock valuation is overly influenced by the bearish interpretation placed on a very long-term “Cyclically Adjusted Price Earnings” (CAPE) ratio: the pre-Depression data are not very convincing. By way of balance, note that if some allowance is made for the underlying profitability of the quoted corporate sector – its likely economic value added, or EVA – then stocks this winter may have been at lower valuations even than in the 1970s.

We face a busy week, with key US economic data and the second LTRO from the ECB. But we continue to think that setbacks in risk assets should be seen as an opportunity to add to long-term positions, not retreat from them.

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Life beyond Greece

Posted on February 17, 2012 by Wealth and Investment Management

“Action may not always bring happiness, but there is no happiness without action” Benjamin Disraeli

In a relatively quiet week for economic and corporate news flow, it’s been the (still) unfolding ‘Greek tragedy’ that has commanded the bulk of the market’s attention. Another deadline has been set for Monday, though whether this is any more credible than the last several is hard to say.

This week has seen Greece’s stakeholders attempt to sound more relaxed about the potential ramifications of a messy default. This studied insouciance has been accompanied by EU negotiators taking a harder line with Athens regarding the implementation of a further austerity programme. The fact is, no one knows for sure the broader implications of Greece defaulting on its debts. The increased confidence shown by some in the midst of current negotiations is no doubt helped by the ECB’s recent activities, as well as the bail out funds still sitting on the sidelines, but the reality is still untested.

This is, of course, is not the only uncertainty on the horizon. Rising oil prices this week testified to more aggressive rhetoric out of Tehran. However, in the context of a signalled move back to the negotiating table, Tehran’s threats could be seen as an attempt to strengthen their hand.

Upcoming French elections similarly have the potential to hurt investors, particularly if the French electorate vote the way they have recently polled.

All this, alongside the fact that equity markets are now almost back up to levels from which they fell so dramatically half way through last year, and you can understand why some in the market are starting to wonder whether the rally in risk assets is about to end. Near term, we believe there is potential for a pull-back given the size of the rally so far and some of the near-term uncertainties out there. However, there are still several reasons why we believe investors will benefit from having a slightly greater than usual allocation to risk assets within a balanced portfolio.

The US recovery now looks to be on much more stable footing; the jobs market is gaining momentum; manufacturing and non-manufacturing order books look healthy; and there might even be tentative signs of life in the long-dead housing market.

In Europe, data currently points to economies stabilising rather than lurching lower. We have credible new governments in place in several of the most troubled countries: Spain and Italy are two important examples.

Central banks around the world continue to do their bit to maintain financial stability. Real interest rates in the developed world remain at record lows, while emerging market central banks have been starting to unwind policy. The ECB has been particularly helpful with its lending operations, which we will see more of at the end of this month, while US monetary authorities have been similarly active for some time now.

With asset class valuations still focused on a markedly gloomier outcome than we think is likely, some exposure to risk should be rewarded, though a degree of sangfroid may be required.

Will Hobbs, Equity Strategy and Fadi Zaher, Fixed Income Strategy.

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Western opportunities amid the dangers

Posted on February 10, 2012 by Wealth and Investment Management

Kevin Gardiner, Head of Investment Strategy EMEA

“The report of my death was an exaggeration…” Mark Twain

A visit to Asia is always a tonic for a European strategist, even after a Saturday night and Sunday morning spent on the tarmac at Heathrow counting snowflakes. Here, there’s too little growth and too much debt. There, it’s just the opposite. Even the most pointy-headed pundit sees their GDP spreadsheets spring to life as the plane windows fill with container ships at anchor off Singapore, Jakarta or Hong Kong – a sight that must surely be one of the wonders of the modern world.

In a very brief trip this week, in addition to hearing more about that growth at first hand – most notably, the opportunities (and frustrations) in Indonesia, recently upgraded to investment grade by two of the rating agencies and currently one of our local strategists’ favourite markets – it was down to me to present our thoughts on the developed world to local investors in a couple of New Year road shows.

The presentation was titled Another Year of Living Dangerously, but in keeping with this being the year of the Dragon – it’s not often the Welsh flag is one of the best-received slides in the pack – I focused on the potential for good fortune alongside those dangers. Readers of In focus and Compass will know that we see the relatively decadent western markets as currently offering most tactical investment opportunities – simply because immediate expectations here and in the US are likely too downbeat.

To make a positive case for developed world investments required tackling head-on the two big concerns that Asian investors (like others) have about the West: the euro crisis and US debt. Against a backdrop of continuing stalemate in Greece – which even now retains the ability to trigger some renewed market volatility – I argued that the ECB’s liquidity provision has very visibly reduced interbank tension, aiding our long-standing “muddle through” scenario. And a resilient US economy is much less puzzling if you’re aware that despite all that debt, the US consumer is still a massive net creditor, with a net worth equivalent to roughly four times US GDP (and little altered in 50 years).

The case for solid growth in the US led naturally on to a brief comment on the dollar. For many Asian investors, the dollar is an important store of value, and a major invoicing currency for their companies. We have few strong convictions about the big four currencies currently – we focus instead on a long-term positive call on a basket of Asian currencies indirectly linked to the Chinese renminbi, and most recently on a shorter-term call centred on our belief that the Swiss National Bank will successfully defend the franc’s cap against the euro. But we think the dollar can stay firm, even as risk appetite revives.

More topically, we are sceptical that the growth of the offshore renminbi market means that the dollar’s days as a reserve currency are numbered. One of the points often overlooked here is that for a currency to be a reserve asset requires that there is a lot of it in circulation outside the domestic economy – which is difficult to achieve in the context of not just capital controls but, more importantly, a large ongoing current account surplus.

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A sense of perspective

Posted on January 27, 2012 by Wealth and Investment Management

‘Death by PowerPoint’ is an ever-present danger at strategy roadshows. Audience participation helps keep it at bay. Recently I’ve asked for a show of hands on two questions. The first is: ‘Who thinks the global economy is in great shape?’ The rolling 12-month response is approximately nobody. The second: ‘Can you name a time when the material conditions of life for the average person on the planet were significantly better than today?’ Here too the response is negligible.

The point this illustrates is the importance of context and perspective in the investment debate. Everyone is aware that in some sense the global economy is troubled. At the same time, they are also aware that in an underlying sense (say the ability to shelter, feed and clothe the average human) it’s really doing rather well.

Investors are currently focused almost exclusively on growth, and the news here has of course been poor. In the fourth quarter for example, UK GDP fell by 0.2%, and we estimate Eurozone GDP fell by a similar amount. Even the US economy grew in all of 2011 by only 1.7%. But the level of economic activity is overlooked, and the average standard of living is likely still very close to an all-time high.

Sometimes the differing perspectives become very visible – a good example isJapan. First time visitors arrive having read about Japan’s ‘lost decade(s)’ of growth, and its large budget deficit. What they find are startlingly high levels of efficiency, infrastructure and all-round material well-being (to say nothing of general civility).

But if the focus on short-term growth rates becomes too intense, some asset prices can diverge a long way from those warranted by the underlying level of (say) corporate profits or solvency. To some extent, this is what we think has happened of late. The divergence may represent a longer-term opportunity: at some stage those levels may start to exert a gravitational pull back towards more appropriate valuations (though Japan is not our favourite investment currently).

Actually, even the growth debate may be taking on a less negative tone. Some important forward-looking indicators in the big developed economies have been drifting higher in the last three months. This week, we saw key manufacturing surveys in the UKand even Continental Europe beat expectations. If next week’s US ISM new orders index were simply to maintain its prior level, our composite ‘G3’ manufacturing indicator would rebound to the highest level since April 2011 – a quarter of a standard deviation above its long-term average.

Meanwhile, in response to the ECB’s massive intervention, the euro crisis – which is largely and understandably responsible for that short-term, incremental focus – may be (as we thought it would) showing signs of stabilising. The interbank spread has drifted back down to levels not seen since October while Italian, Spanish and Irish 10-year benchmark bonds are flirting positively with 6%, 5% and 7% yields respectively.

Renewed volatility is still likely. Another EU summit looms, with Greece, and perhaps Portugal, still capable of disappointing. Tensions remain in the Gulf, and the political situation in France is sparking investor questions. But the positive start to 2012 by risk assets is not without foundation, and we continue to recommend that long-term balanced portfolios hold more risk assets and fewer government bonds than usual.

Kevin Gardiner, Head of Investment Strategy EMEA

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Henk Potts Weekly Market Update: Monday 23 January 2012

Posted on January 23, 2012 by Wealth and Investment Management

Henk Potts, Barclays Wealth Equity Strategist, appears regularly on Radio 4, CNBC, Bloomberg and other international media. Listen to his review of the past week in the markets and preview of the week ahead.

This broadcast is not a personal recommendation and you should consider whether you can rely upon any opinion or statement contained in this broadcast. It may not be reproduced (in whole or in part) to any other person without prior written permission. Law or regulation in certain countries may restrict the manner of distribution of this broadcast and persons who come into possession of this broadcast are required to inform themselves of and observe such restrictions.

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Opportunity in volatility

Posted on January 20, 2012 by Wealth and Investment Management

Emotionally resilient investors can take advantage of an anxiety premium
There can be a number of hidden gems available at very good prices

There is perennial debate about whether stock selection improves investment performance over the long term, when compared to the low cost, and low effort approach of simply buying index products. At the heart of the debate is the question not of whether some stocks in the index will do better than others – this will always be the case – but whether those which will perform better can be reliably selected in advance.

Over short holding periods this is always doubtful: at best: there are simply too many idiosyncratic and unexpected events that can lead any one ‘good’ stock to disappoint over any specific short time horizon. Furthermore, in the turbulent, ‘risk on, risk off’ markets we’ve experienced since August, picking individual stocks seems to have little discernable effect, as markets rise and fall as a whole, led by changes in political events or investor sentiment, whose effects are common to all stocks.

However, this high volatility, high degree of focus on short term news flow, and lack of discrimination between individual stocks provides an environment potentially full of opportunity…that is, for those with the emotional resilience to stick with investments through the ongoing turmoil. This is true both with respect to the level of the market as a whole, and also for purchasing individual stocks at particularly good long-term value.

In fact, it is the very anxiety induced by the market turmoil that brings the first source of value: when times are very stressful and uncertain, investor focus tends to shift to excessive concern about what will occur in the short term, and away from calmer reflections on long term, sensible, value opportunities. Emotional time horizons shorten, and this enhanced nervousness naturally causes investors to shun investing more than if they were taking a more rational long term perspective. This emotionally induced lack of demand for risky investments drives markets lower than can be justified by a less myopic evaluation of risk and return. In other words, long term and emotionally resilient investors can take advantage of the temporary anxiety premium caused by the high level of stress, fear and myopia of everyone else in the market.

This is not to say that markets aren’t still risky – they are – but in times of stress markets are not only pricing in risk, they’re also pricing in the emotional anxiety of all those investors who have taken their eyes off their long term investment goals. So, unless we think that markets are significantly underestimating the true risks, then times of turmoil are good entry points for long term investors.

But what about individual stock selection? Well, another feature of stressed investors with myopic emotional time horizons is that their perspective becomes much less nuanced – fearful investors often flee risky assets as a whole, without discriminating effectively between high and low quality assets. Correlations increase and all stocks move up and down together depending on whether the prevailing sentiment is ‘risk on’ or ‘risk off’. When markets fall, investors sell the good with the bad. This means that not only is there an anxiety premium for the market as a whole, but that good stocks can be dragged down with all the rest, despite very robust long term prospects.

Thus, at times when stocks as a whole are being shunned there can be a number of hidden gems available at very good prices for those with the knowledge and expertise to unearth them. In the short term they may well continue bouncing up and down with the market as a whole, but a basket of such shares, carefully selected, allows investors to supplement their portfolio with assets purchased at deep long term value, at a time when most market participants are more concerned about short term emotional comfort.

Greg B Davies, PhD – Head of Behavioural and Quantitive Investment Philosophy

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Another year of living dangerously?

Posted on January 20, 2012 by Wealth and Investment Management

“Snakes! Why does it always have to be snakes?!” Indiana Jones

No one would be surprised if the global stock market, having made a strong start to 2012, were to re-encounter its deepest fears at some stage. The three broad danger areas facing investment markets in late 2011 are all still out there. Namely: unresolved issues in the euro area; uncertainty about economic growth in the US and China; and, more subtly, a deep-seated investor scepticism about financial markets and analysis (and with it, a marked reluctance to take risk).

In the case of the euro area, we still don’t know just how widely (and messily) distributed will be the private sector losses onGreece’s bonds. Funding of the EFSF and the pending ESM is still unclear, as is the short-term budgetary outlook for the peripheral countries. There is an EU summit looming, but few investors will be holding their breath on that one.

The growth outlook in the US is still overshadowed by the possible expiry of tax cuts and labour market support, and (for many commentators, though not us) by the perceived need for drastic consumer deleveraging. China’s GDP may not have slowed noticeably yet – the last quarter’s deceleration was not statistically meaningful – but many still warn a hard landing is imminent.

Lastly, investor scepticism isn’t going to disappear any time soon – not least because the crisis has shown that much financial analysis has been in need of an overhaul, as our colleague Greg Davies, Head of Behavioural Finance, explains carefully in his new book “Behavioural Investment Management”.

But this doesn’t mean that there has been no progress at all since the autumn, at least under the first two headings. The ECB’s support for euro area money markets – with another potentially huge second tranche still to come in late February – seems to be capping the interbank spreads that gauge banking stress, as we thought it could. The improved tenor of US labour market data and consumer confidence is looking a little less like a seasonal aberration. Beneath the headline disappointments, US bank results suggest that underlying asset quality is if anything continuing to improve.

We continue to believe that the corner is very slowly being turned, and that both the euro area banking system and the global economy will regain some poise in 2012.

While we share investor scepticism regarding much financial analysis, regular readers will know that we are also wary of what passes currently for received wisdom even outside the pages of the efficient markets textbooks.

How often do you hear (for example): “We can’t pay for our pensions”; “There’s too much debt”; “The euro can’t survive”; or “Things haven’t been this bad since the 1930s”?

None of these assertions are necessarily true, and the last is not just wildly inaccurate but in questionable taste. To the extent that current asset prices have been depressed (or elevated, in the case of bonds) not just by the undoubted risks that are out there, but also by an overly pessimistic climate of opinion, there is more room (eventually) for a sustainable rebound in risk assets as worst fears fail to materialise.

Kevin Gardiner, Head of Global Investment Strategy

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