Monday, September 24th, 2012

Multi Asset Model Commentary 24/09/2012

(This commentary was written originally specifically for the US Dollar Multi-Asset Model)

Market conditions

We are two weeks on from the Europe’s critical week – the one which was supposed to decide the future of the Eurozone – and markets have done what they always do. They have changed the question. We now have to worry about the US fiscal cliff. The fact that we cannot know the answer until sometime in Q1 2012, at the earliest, only adds to its importance as far the commentariat is concerned. Back in the real world, risk conditions are broadly unchanged. The historic volatility of risk assets is close to its low for the year, but the interesting point is that it has not fallen to new lows, despite the good news on Europe.

Current positions

The main change in the portfolio over the last two weeks is the increase in the weighting of US equities and the decrease in US treasuries. Emerging market equities and commodities have also seen modest increases, balanced by a fall in the weighting of investment grade bonds. The weighting of US REITs, still the most preferred asset, is unchanged over the period, but it is now only just ahead of US equities. It may seem strange shifting into US equities close to an all-time high (in total returns), but the real driver is what is happening to Treasuries. The yield on the 7-10 year index is about 1.4%, which is less than the current rate of inflation. This makes it impossible to hold bonds unless there is a clear and increasing danger to the value of risk assets.

Outlook

With all due respect to the bond market vigilantes, nothing can be done about the US fiscal cliff until next year. There are other questions to which we can reasonably hope for an answer before then. First, will QE3 have as powerful an impact on commodity prices as its predecessors? On balance, we think not because the China story is less certain. Second, can emerging markets attract any interest in the absence of an early recovery in China? We think there is room for a positive surprise here. Finally, which asset class is likely to benefit from rising inflation expectations, and the Fed’s new found enthusiasm for mortgage bonds? Our answer is unequivocal: US commercial property, or in our case US REITs.

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