Where in the World?
Markets are all over the place at the moment so what to do?
Well, for those that read this column regularly, you know that I am a great
believer in putting as many of your eggs in as many different baskets as
possible. So, here we go:
With the cash yield basically at zero in the US, Europe and
Japan it is difficult to answer the question why one should invest in US Dollars
or any other Western Hemisphere cash at present. However, the return of capital
as opposed to return on capital may be the prevailing environment leading into
Q4, as the European crisis threatens growth and adds to volatility. When all
correlations move to one, holding US dollars is the safest place to be. However,
Emerging Market (EM) cash rates are relatively high at 5% + yields and their
government balance sheets remain strong. Recent weakness in these EM currencies
has created a buying opportunity for us, as this is one of our favoured asset
classes. Momentum will return once currency volatility settles down. This short
term weakness in EM currencies has created a particular buying opportunity in
South East Asian and Latin American deposits.
As discussed before, US Government bonds, European Bunds or
UK Gilts are to be avoided at current yield levels, on a 30 year view. However,
in the short term, Treasuries are a safe haven from volatility and further short
term gains cannot be discounted. In our view the risk reward has run its course
in this asset class and we have now moved underweight with the exception of EM
bonds, which we believe are in a bull trend, not a bubble. They remain one of
our high conviction positions. Currency volatility has made these local market
EM bonds more attractive, now that we are at the bottom of the price range.
An impressive arbitrage has opened up in the developed world
commercial property market, particularly in London listed property. A 20% spread
between the physical commercial property IPD index and the UK listed blue chip
property REIT (Real Estate Investment Trusts) index has materialised over recent
weeks, due to equities having sold off before the softening of the physical
market. Asian growth remains intact and as such we are still overweight Asian
commercial property, both physical and REITs. Singapore and Hong Kong are a risk
from a residential perspective, but commercial rental growth appears solid in
the region. Global Listed Property is now trading at an average yield of 5.45%
p.a. Japan residential is an interesting sector which we are currently
investigating. Special Situations in Europe abound, with big discounts to NAV
with one of our largest holdings, Terra Catalyst, taking advance of the
opportunities in this sector.
Valuations are back to 20 year averages but are still not
cheap from a normalised earnings basis or 1930ís/1970ís valuation levels.
Developed Markets (DMís) were better value at the start of the year than EMs,
but this gap is narrowing due to market performance and foreign exchange (FX)
revaluation in recent months. Large Cap high dividend companies have solid
balance sheets, but their earnings are the concern. The odds of a global
recession are increasing each week but this is not currently priced into equity
values and we feel it best to wait for Greece to finally admit bankruptcy, or
for some other similar market panic to take prices closer to 1,000 on S&P500.
Remember, if one must panic, it is best to panic first and to avoid European
equities at all costs. Within global sectors, we still favour Technology as
clear winners and losers makes the sector countercyclical. Re Insurance is
trading at 0.8 times book and global large cap value is very attractive from a
free cash flow and dividend yield perspective. To buy on valuation would mean
relying on US and European politicians making the right decisions together with
the non-materialisation of a slow-down in China, both of which remain uncertain
to say the least.
Alternative Strategies had a difficult quarter. The Dow Jones
Credit Suisse Core Hedge Fund Index finished down -4.23% in September, bringing
year-to-date performance to -7.84%. In the Event Driven space, losses mainly
stemmed from relatively concentrated long equity positions, related to special
situations. Global Macro managers declined following sharp reversals in precious
metals, such as gold which posted its worst monthly loss since 1983. Volatility
of emerging market currencies/bonds has also added to the trend following funds
underperformance. Compared to the year-to-date drop of -15.36% for the Dow Jones
Global Index, hedge funds have provided some level of relative capital
preservation to date this year; however, all strategies appear to be feeling the
pain with market uncertainty at an all time high. The volatility and seesaw
nature of equity markets since the initial early August collapse in risk assets
is not helping, but unlike 2008 the liquidity and credit issues are not in
evidence this time.
As we have learnt from Nassim Nicholas Talebís impressive
book - The Black Swan: The Impact of the Highly Improbable risk models
cannot guard against the occurrence of highly unlikely, extreme events. His
example was the discovery of black swans by Europeans in Australia, when all
previous experience suggested that swans could only be white. The improbable
Improbable had transpired. Perhaps the Europeans can cause another unlikely
event at the Rugby World Cup Final this year?
The past Quarter has been very difficult for risk assets, but
we have not encountered any Black Swan events yet. Most asset classes were
negative but, interestingly, not all were correlated or weak at the same moment
in time. Problems in Greece and the sovereign debt crisis are well known and
priced into European risk assets although perhaps not the Euro just yet. An
improbable Unknown would be an actual sovereign default or problems
within the ECB itself. The US recession is priced into risk assets, on a 50%
probability basis, but a further Black Swan event such as an actual recession or
social unrest is not. Finally, China is one big unknown Unknown.
To buy global equities at the start of this Quarter on the
basis of good value requires a bet on two things: firstly the ability of
European and US politicians to organise a booze-up in a brewery and secondly
fears around a Chinese slowdown proving unfounded. Is this a finely balanced bet
or a Black Swan event?
The above data and research was compiled from sources
believed to be reliable. However, neither MBMG International Ltd nor its
officers can accept any liability for any errors or omissions in the above
article nor bear any responsibility for any losses achieved as a result of any
actions taken or not taken as a consequence of reading the above article. For
more information please contact Graham Macdonald on