Market View - October 2010

Last month's advice to "Be greedy when others are fearful" turned out to be spot on as global equity markets surged during September (the S&P 500 in the US gained more than 9%, the FTSE 100 climbed more than 6.5% and the MSCI Emerging Markets index up over 10%) putting most equity markets into positive territory since the start of the year!

However while September's rally in stocks was most welcome, and helped confirm our view that equities is the asset class that offers the most attractive risk adjusted potential returns for investors for the foreseeable future, the path ahead is likely to remain rocky and strewn with both known and hitherto unknown obstacles! The risks are especially pronounced in terms of central banks opting for the wrong strategy as The Times Chief Economist Anatole Kaletsky warned towards the end of the September.

Anatole had strong words for some of his economist contemporaries at major Central Banks when saying in his column "Stop Navel gazing and admit something's wrong!" He went on to comment on a recent speech by the Chairman of the Federal Reserve, "Ben Bernanke's defence of economics merely confirms that it's clinging to outdated and discredited theories"

"The financial crisis was more a failure of economic engineering and economic management than of economic science. If the most useful economic ideas date back to the 1870's and 1930's what have academic economists been doing since? The answer at least from the macroeconomists who dominate leading universities, central banks and international institutions (as opposed to industrial economists and investment analysts who work in business and the financial markets) is mostly gazing at their navels".

"The reason why economics has progressed so little beyond the insights of its founding fathers has been the convention adopted since the 1960's that all senior economic ideas must be expressed in equations not words. By this standard most of the genuine greats, Smith, Ricardo, Keynes, Schumpeter and Hayek would be rejected by academic journalists and not recognized at all.

Anatole concludes "As long as central bankers such as Mr. Bernanke and for that matter Mervyn King pay lip service to clearly discredited concepts, it is hardly surprising that confidence is lacking in their ability to manage the economy. To rebuild confidence in the economics, the first step is to admit something is wrong"

While the amount of money invested in global equities last month remained disappointingly low despite the surge in stock prices (suggesting many investors remain sceptical that the Great Depression is over), there was no doubting the appetite for US Treasuries as evidenced by the statistics (from the Washington DC trade body "Investment Company Institute") showing that during the first three weeks of September more than $20 billion poured into mutual bond funds on top of the more than half a trillion dollars that has gone into the sector in the previous two years.

So are US bonds in a bubble? We do not think so, at least not just yet! While Treasury yields generally offer little value versus expectations for cash returns, it is debatable whether it can be argued that bonds are at bubble valuations. US Treasuries appear to be pricing in a long period of sub-par growth, but do not appear to be pricing in a Japanese style deflation as many critics have been fearing.

From an overall asset allocation perspective, however, the returns from both cash and Treasuries are likely to be poor, especially since one of the stated goals of quantitative easing is to drive up asset prices, or in other words, drive down the value of cash. We continue to believe that other asset classes such as equities or sub-investment corporate bonds offer better prospects for medium-term investors!