Probability-based investment modelling for professional and institutional investors
| After last week’s note about excess volatility in the US, we look at the experience of other developed markets in 2000, 2007 and 2015. In a majority of occasions, material increases in excess volatility signaled the onset of a correction and/or the transformation to a full-scale bear market. There are no such signals at the current time, which we regard as comforting, though not conclusive, evidence in favour of our equity overweight. |
Across a broad spread of asset classes and strategies, investors have responded to recent dollar strength by putting on a series of trades which suggest they expect it to continue. This doesn’t prove that it will, but the market reaction has been consistent and immediate.
Europe, apart from the UK, is producing better risk-adjusted returns than most emerging markets. These have been flattered by favourable FX movements, but there are good fundamental reasons for this as well. Unless the euro gets too strong, we don’t see why investors would want to change a winning formula, anytime soon.
We agree with consensus that an equity correction could happen at any time. However, we will not be buying the dip in the US. We much prefer the Eurozone, which has a habit of late-cycle outperformance. We also prefer Japan, which has just hit a new 22-year high, to EM, which keeps failing at resistance just above current levels.
There is a lot of concern that the ultra-low level of volatility may herald the death of the global equity bull market. But historically this has been a poor indicator (as have Tech bubbles). Two which have worked in the past are very low exposure to US investment grade credit and very high exposure to Eurozone Equities, both of which we have now. But the lead-time from here could be between 10-30 weeks.