Monday, June 25th, 2012

Global Equity Models Commentary 25/06/12

(This commentary was written originally specifically for the Sterling Global Equity Model)

Market conditions

For asset allocators working in currencies other than US dollars, the safe haven trade poses some interesting challenges at present. When risk-appetite falls, government securities in the US and UK tend to rise, and the dollar tends to rise against all currencies, including sterling. So far, so obvious. What happens when this unwinds is less obvious. Investors take profits in gilts, but the move back into equities is complicated by the reversal of the currency effect. UK equities benefit because there is no currency effect. Japan benefits because of yen strength, and US equities are hampered by a weak dollar.

Current portfolio

Exposure to UK gilts has fallen for the second week in a row, and with the benefit being shared mostly between UK, US and Japanese equities.  Japan is now clearly preferred to Eurozone and EM equities. We think the currency effect is the most convincing reason for the increase in positions in Japan. There are similarities with what happened in late November and December of 2011, when investors started to increase risk again.

Outlook

For the reasons stated, we would be surprised if the move back into Japanese equities was anything other than short-lived. We would expect the US and UK to take a larger share of the benefit if the rally extends into Q3. We see little hope for a substantial increase in Eurozone exposure. Firstly excess volatility remains higher than the other four regions, which raises the hurdle rate for risk-efficient investment. Secondly the Eurozone economy needs a weaker euro, which will penalise performance in sterling terms -and it is just possible the ECB will do their bit with a rate cut.

 

 

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