Market View - October 2011

Financial markets have recently returned to alternating between 'risk on' (when markets are in buoyant mood) and 'risk off' (when they are anxious) with bewildering rapidity.

September proved to be another roller coaster month for investors as global equity markets plunged mid-month on global growth fears and eurozone debt worries, before then rallying on hopes that policymakers may at long last be close to finding a lasting solution to the European saga.

To confuse and frustrate matters further, the supposedly more robust asset classes, such as emerging market equities, have suffered greater losses during the risk off periods, and during 2011 have fallen by roughly double the 11% falls suffered by MSCI global equity index. As the recent Buttonwood article in The Economist newspaper observed, the safe haven currencies have been the asset classes that have tended to perform best during risk off days; however, following action by their respective authorities to dampen the strength of the Swiss franc and the Japanese yen "the dollar became the haven of choice in the latest sell off, despite the US's continued structural problems, because there is simply nowhere else to hide"

The article quotes David Bloom, a currency strategist at HSBC who further explains "The Treasury bond market offers a level of liquidity that no one else can match; long term fiscal problems matter little when investors are hoping to protect their portfolios for only a couple of months." Also under the spotlight is the recent failure of gold to continue its steady outperformance of the last decade, having fallen from more than $1,900 an ounce to less than $1,600 at one stage during the month.

The Buttonwood article concludes "Even precious metals cannot escape the curse of the portfolio investor. The same fund flows that can drive a price up can push it back down again. Standing out from the crowd is harder in markets than it is on screen." The market's schizophrenic behaviour reminds us of the old saying "the  market will do whatever it has to in order to ensure a majority of investors are wrong the majority of the time".

Ash-Ridge Asset Management however remains cautiously optimistic and agrees with Ashburton's Global Strategist Tristan Hanson who recently said "Financial markets have suffered a widespread deterioration in sentiment recently. Global equities have declined sharply and emerging market assets have been hit particularly hard, leading to an abrupt rally in the US dollar against most currencies.

"At the forefront of concerns are prospects for weaker economic growth, the ongoing European debt crisis and a fear that policymakers are running low on ammunition with which to fight a further slump in the world economy. While we share some of these concerns, recent rapid market movements are suggestive of indiscriminate selling and not likely based on a rational assessment of the fundamental value of financial assets.

Tristan concludes, "In a rush for liquidity, overcrowded trades (e.g. emerging market currencies) and even previous safe havens have declined (e.g. gold). "In our view, the force of the recent sell-off has been disproportionate to the evolving economic news flow".

One of the most frustrating aspects of the whole euro-zone debacle for investors is the undeniable value that is on offer in some European stocks and sectors, and The Economist’s Buttonwood article observed, "The European cyclically adjusted price – earnings ratio (which smoothes earnings over ten years) is 12.1 according to Absolute Strategy Research. That ratio compares with one of 20.1 in the United States, as calculated by Robert Shiller of Yale University"

Meanwhile September showed that "The market will do whatever it has to in order to ensure that the majority of investors are wrong the majority of the time!" The S&P 500 in the US fell more than 7% in September and is now down more than 10% during 2011 (it has actually fallen more than 20% since its April 2011 high for the year signifying it has now officially entered a bear market phase), while the FTSE 100 here in the UK fell almost 5% last month and is down more than 13% since the start of the year.

Reflecting the ongoing concern for eurozone debt, the FTSE EuroTop 100 is down more than 17% during the first nine months of this year, while contagion from developed economies to emerging markets has seen the latter fall 23.53% in 2011! Despite many fixed income specialists warning of the risks of being exposed to government debt markets, the JPMorgan Global Government Bond index has defied expectations and risen more than 7% so far this year!

For the moment fundamental value is being overlooked as the risk off phase of the market prevails, but eventually we remain convinced that blue chip funds, and stocks with an attractive longer term remit and/or compelling yield proposition will deliver outperformance to patient investors!