How Broad Was My Rally

Friday, May 31st, 2024

Quality available at a discount in Europe

Many investors are still waiting and hoping for the rally in US equities to broaden out. We see no evidence of this in terms of size. Our US equity model has Small Caps almost exactly in line with their benchmark weight, and they have been in the neutral zone for most of the last two years. If anything, their outlook has deteriorated in recent weeks, as hopes for rate cuts continue to be disappointed. We also think that the idea of broadening out is dangerous if it means reducing the liquidity and quality of the portfolio this late in the cycle. There is one area where we think this may be an attractive strategy. There is plenty of quality available in large-cap European equities at a significant discount to US valuations. This could be one reason why the Eurozone and the UK both rank ahead of the US in our tactical allocation model.

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Two Fashion Victims

Friday, May 17th, 2024

UK and China climbing a wall of worry

Over the last month, two large equity markets, which have been out of fashion for many years, have suddenly surged up our rankings. There is no natural linkage between the UK and China, but both may be benefitting from a view that the authorities are making progress in tackling the big issues relating to their economies: the real estate crisis in China and stagflation in the UK. In China, we don’t think this is the end of the housing crisis, but we do think that recent announcements will successfully insulate the banking industry from any further contagion. China can once again be evaluated on the basis of its growth prospects, and not its balance sheet.  In the UK, recent data paint a picture of accelerating non-inflationary growth, which should be rewarded with falling interest rates. The real causes of the lack of enthusiasm for UK equities are more structural and relate in part to the biases of UK domestic investors. Behind the scenes, the Government is working hard to change these attitudes and these efforts will come to a peak with the planned sale of some its stake in NatWest Bank to UK retail investors, later this summer.

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The January Effect

Wednesday, December 20th, 2023

Hangover or Party On

US investors have enjoyed a year’s worth of returns in seven weeks. This has been a rally of everything – except oil. Even real estate has had its moment in the sun. US Equities are approaching overbought territory and will probably get there by the end of December. US Treasuries – long and short – will get there in January, at the current rate of progress. But US and European credit is already there. There has to be some sort of reaction to recent strength. We expect credit markets to weaken first, which will be used to justify the recession narrative, which will then impact equities. Government bonds may continue their rally for a while, but we think the big theme for the year will be the US budget deficit. Round 1 is in January, the next one is in Q4. Bond vigilantes are not dead, just sleeping.

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For the Unbelievers

Friday, June 2nd, 2023

Low risk, not high return, makes Japanese equities attractive

Our proprietary volatility index dropped out of the danger zone three weeks ago, having warned us back in May 2022 that something was going to break. This helps to explain why investors feel so comfortable with equity risk at the moment. All equity regions have levels of realised volatility below their 25-year median and only US Treasuries are still in the danger zone. The volatility of Japanese equity returns is in the 13th percentile of its 25-year history. Investors don’t have to believe the new (or is it the old) shareholder activism story. The risk-cost of entry into Japanese equities is low by historical standards and that is enough to make the risk-reward calculations work.

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What To Do About China

Saturday, May 6th, 2023

It’s an ill wind which blows nobody any good.

EM Equities are in deep trouble and we see no early turning-point, mainly because China is also suffering. The strong outperformance promised after the end of lockdown has not materialised, but more importantly, our models suggest that the local equity market itself is not functioning as it should. Two relatively obscure indicators: active weight and persistence of winning and losing sectors are either at, or very close to, 20-year lows. This suggests that investors are struggling to construct portfolios, which deliver an appropriate balance between risk and return. This is not a problem China has suffered from until recently and if it continues, international investors may have to regard this as a secular trend, not a cyclical aberration. If EM and China are not attractive destinations for international capital, other regions must benefit on a relative basis – and the most obvious is Europe.

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If It Walks Like a Bull

Friday, February 3rd, 2023

It can still fall over in the near future

Our mainstream sector and asset allocation models are producing signals which we would normally expect to see that the start of a new bull market, and not all what we expected in Q4. Much of this is because we have had two bullish surprises (end of zero-Covid in China and the postponement of the US recession), but we should also acknowledge that equities in the UK, and probably the Eurozone, are going to reach new all-time highs in the near future. What is this, if not a bull market? Alas, the same is not true of the US. There is already a recession in US earnings estimates, driven by tight labour markets, margin compression and over expansion in the Tech sector. Estimate drawdowns can last for over two years and the current one has only been going for 31 weeks. New bull market, or bear market rally, call it what you will, it isn’t going to last much longer.

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Upside Protection

Monday, November 21st, 2022

The need to hedge against unexpected good news

Our models are slightly conflicted at the moment. The multi-asset models, which mimic sophisticated institutional portfolios, are significantly more bearish than our simple equity vs government bond models, which are more retail-orientated. Before we dismiss the latter is just being wrong, we should at least try to explain the difference. Retail investors may be trying to hedge against the possibility of unexpected good news: a shallow US recession; a peace deal in Ukraine; or an end to zero-Covid in China. Any one of these could result in significant upside for global equities and the joint probability that none of them will happen is lower than you think.

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Switch Off the Autopilot

Friday, October 7th, 2022

Currency impact on equity allocation is now extreme

The strength of the US dollar has hugely overstated the attractiveness of US equities to both US and international investors. The currency effect against developed markets is more powerful than it has been in all but 3% of weekly observations, going back to 1995. This is fine while it lasts, but one day it will go into reverse. Meanwhile, the dollar index is approaching generational highs. After the last tech-bust and peak dollar, US equities underperformed the rest of the world, in dollar terms, for the next five years (2003-08).

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Messy Reality

Friday, August 19th, 2022

Using sector betas to evaluate investor attitudes to risk

We wanted to get a handle on which equity regions had the most risk-averse investors, so we measured the beta of our recommended overweight and underweight sectors. We found that reality is much messier than we thought and that pre-conceived, US-centric attitudes to risk do not translate well to other regions. Our numbers suggest that Eurozone investors are the most risk averse, but the sectors they use to express this view are not the ones that US investors would choose.

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The Great Undiscounted Risk

Friday, August 5th, 2022

Our models expect a bear-steepening in the US yield curve

There is a widespread and unspoken assumption that the Fed will curtail QT if the US economy starts to suffer and that there are no circumstances in which it would accelerate it. We think this assumption needs to be tested. Our models suggest a bear-steepening in the US yield curve is more likely than continued inversion or a bull-steepening. If we are right, this can only be bad news for US and global equities, because our models suggest that the equity rally is completely explained by the recent collapse in 10-year yields. Indeed, equities have underperformed bonds on a risk-adjusted basis since the end of June. If the bond market becomes less supportive later this year, we think there is another significant down-leg in store for equities.

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