Monday, January 7th, 2013

Happy New Year

Happy New Year. Our forecast that the rally in risk assets would continue into 2013 has been borne out by events, but it required the President and Congress to reach some sort of agreement on the US budget. Santa made it in time for New Year even though he did miss Christmas. The trouble is that we need to have the next agreement in place in time for the Easter Bunny.

First the good news: for every domestic equity bond relationship we follow (i.e.UK equities vs UK gilts and so on) risk appetite has been rising strongly since late November. This shows up in the average level of risk each model recommends and more importantly in the probability curve. This is our proprietary signal which currently shows that short run risk conditions are more favourable than the long run risk conditions. This normally acts as a leading indicator for the way the average is likely to move in the immediate future. Of course it can change, but it is good news while it lasts.

Now the bad news: the US is the one major region where the model is not heavily overweight equities vs bonds. Here the call is only 60/40. This matters partly because – in terms of timing not quantum – the US led the recovery in risk appetite in Q4, and partly because so much investment commentary is US centric that it would be easy to dismiss the bull markets in other parts of the world.

And last the ugly news: the recent rally has hardly moved the dial for most commodities, whether measured in dollars, sterling or euros. To us, this suggests that their status as the lead indicator of risk appetite is on the wane. For most of 2012, even when their returns were positive, the volatility attached to them was simply too high to make them attractive in risk-adjusted terms. In this case, we suspect that the New Year will look much like the Old.

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