Tuesday, October 9th, 2012

Multi-Asset Model Commentary 09/10/2012

Market conditions

Rotation, rotation, rotation. The only constant is change. Asset classes which have been out of favour all year now look as though they might attract a bid. EM equities which have underperformed developed equities and EM debt for most of Q2 and Q3, are developing enough momentum to suggest that they may produce an acceptable return per unit of risk in Q4 2012. US REITS and EM bonds, which have been at the top of the leaderboard, see the momentum of returns start to falter without any compensating reduction in volatility. In general, risk assets look more attractive than they did four weeks ago, but there is clearly a case that the improvement has been too much too soon. Signal quality is still poor and unreliable.

Current positions

The multi-asset portfolios in all three currencies have moved to a net risk-on position over the last month. In the US dollar model, EM equities and investment grade corporate bonds have gained at the expense of US REITS and US Treasuries. Despite a reasonable performance US equities have not seen any increase in their weighting. In the euro portfolio, investment grade debt still languishes, partly because so much of the product on offer comes from the financial sector, which is at the heart of the crisis. EM equities have seen the biggest increase in weight, but Pan-European equities continue to be the largest asset class. In the sterling model (which is restricted in the number assets it can own) there is little change apart from a small increase in EM equities at the expense of EM debt. In all three models, the exposure to conventional medium-term government bonds is now very low.

Outlook

The key question for the next few weeks is whether the move back into risk will translate into more appetite for high beta assets like EM equities and commodities. Like most other commentators we believe that the move back into risk has everything to do with QE Infinity rather than any improvement in the outlook for global growth. We also note that the consensus is now expecting margin compression in the non-financial sector in the US Q3 results seasons. We cannot see any change to US monetary policy between now and the US Presidential election. So the answer to our question is, “Yes, Probably.” We stress however that signal strength is still poor and unreliable.

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