Monday, July 30th, 2012

Multi Asset Model Commentary 30/07/2012

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

Market conditions

As part of our process we spend a lot of time looking at the volatility of average weekly prices, as well as the more traditional week-end prices. Even over the short-term, the volatility of week-end price should normally be higher than the volatility of the average price. If the relationship is the wrong way round (as is currently the case for US equities) we sit up and take notice. There is no need for conspiracy theories about the “plunge-protection squad”. We just have to recognise that the volatility of week-end prices (the indicator more people look at) is suppressed and is likely to break out in the near future.

Current positions

This observation has little impact on our current asset allocation, which has been effectively unchanged for the whole month. The model remains resolutely risk-off, with the largest two positions in US REITs and Treasuries. However there has been an increase in the recommended weight of corporate bonds, all of which has come at the expense of US Treasuries. It is hard to think of a compelling fundamental reason for this trade, so we are inclined to put it down to asset rotation. Amongst the risk assets, US equities are still preferred to emerging market equities and commodities.

Outlook

Our observations about suppressed volatility may be worth remembering on Thursday of this week, when the ECB meets. Expectations are running high that the ECB will announce a series of measures which will “do whatever it takes” to preserve the Euro. It is hard to give these statements the benefit of the doubt, given the past record of some of the speakers. We will have to wait and see, but the market action in reaction to these statements makes the response to Thursday’s announcements almost binary. If they exceed expectations, all risk assets will rally, not just US equities. If they don’t, the suppressed volatility may be unwound in the opposite direction, with traumatic results. We remain comfortable with our risk-off stance.

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