Tuesday, June 2nd, 2015

Waiting for Godot

Most people have heard of Waiting for Godot, but far fewer (including yours truly) have the stamina to watch it all the way through. In the play two characters sit around waiting for the arrival of a man called Godot, though why they are waiting is never made clear. They perform mundane tasks and make meaningless conversation for the whole of Act 1, until they are told right at the end that Godot will not be coming today. The second act takes place the next day and everything is the same, only slightly different, until they are told once again that Godot will not be coming that day and the play ends. The similarities with the Greek bail-out negotiations are obvious with one crucial difference – at least the theatre audience gets to go home after Act 2.

For the last month our models have described a world where everything is the same, only slightly different. For example, in our US equity sector model, no sector has changed its ranking for the last three weeks and there have been only three changes in the last five weeks. (The average is about two a week). Every sector is trending sideways. It is the same story in the other equity regions (Japan, Europe and the UK) as well as our asset allocation model and credit models. There is no leadership to the upside, and there can’t be leadership to the downside until we know exactly what it is. This tells us that investors think they are prepared for Grexit, that they want a decision, but know they may not get one. In the meantime there are some mundane tasks that investors can perform which do not involve taking a view on the outcome or the timing.

Reducing Energy exposure: The Energy sector has not been out of the bottom two places in any equity model since January, but we have seen a considerable reduction in the recommended underweight. In the middle of May the probability curves suggested that the sector might overtake some of the other laggards, but in the last two weeks they have turned down everywhere in response to the failure of oil prices to break above $70/bbl. We see a similar pull-back in our country models with countries such as Norway, Russia and Mexico faltering after some good progress. Our conclusion is that the short-covering rally is over and the sector and these countries may soon retest their lows.

Buying dollar strength: The recent weakness in the dollar looks to be over, at least against the yen and sterling. A view on the euro is of course subject to a view on Grexit. The effects vary from region to region, but for US investors this reduces the pressure to buy overseas equities and allows them to add to their holdings of US$-denominated fixed income. This is one reason behind the recent weakness of EM equities. Financials is our preferred sector across US high yield and investment grade credit.

Using Japan as a safe-haven: The third point appears to contradict the second, but only if investors haven’t done the trade already. For the last two months our asset allocation models have shown that Japanese equities have (a) better momentum and (b) lower volatility than all other equity regions. This includes the US and is true with or without a currency hedge. This suggests that Japanese equities will be the least-affected major market if ever Mr Godot arrives – and if he doesn’t.

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