Politics makes Threadneedle’s Burgess boosts cash holdings

The euro may have been saved, but the deficit in democracy that has been the price may yet hurt investors because of hightened political risk, argues Threadneedle Investment’s CIO Mark Burgess.

Markets continue to be buoyed by the broadly supportive liquidity backdrop which has been around since the beginning of the year. The second tranche of the LTRO was provided last week and another 530bn euros was lent to some 800 banks, and it is our expectation that this will continue to be put to work. The positive ripple effects of the first tranche are still being felt by the challenged European bond markets. In particular Italian and Spanish bond yields have fallen sharply as LTRO money is invested. This bond market rally, and the accompanying removal of solvency risk in the European financial system is one reason why risk assets have rallied this year.

Elsewhere, news from the US continues to (modestly) positively surprise with upward revisions to 2011 Q3, and Q4 GDP data, with the news from the labour market being particularly encouraging. Companies globally remain very soundly financed and are generating prodigious amounts of cash which will need to be deployed at some stage. We have benefitted from our overweight position in equities, and in risk assets generally and our multi asset funds have outperformed YTD.

We are however becoming increasingly concerned with rising tension in the Middle East, and the accompanying rise in the oil price. In a number of currencies oil is now trading at an all-time high and is in danger of becoming a head wind to the fragile recovery being seen in the developed world. The risks are that this tension escalates further which in turn leads to an oil price spiking higher; this would certainly undermine consumer confidence in the US, but more broadly would significantly impact risk appetite. In addition, the potential for an unintended political outcome in Europe remains high, and I remain concerned by how profoundly un-democratic the fiscal compact is in its design and implementation. This is likely to lead to further volatility and potentially unexpected political outcomes.

Consequently we have decided to further increase our cash position, such that we are now overweight cash in the multi-asset funds. In equities we are most overweight in Asia Pac and we are reducing this overweight by 0.5% to 0.5%. Although this remains the fastest growing part of the world economy, history shows us that this is no protection in terms of equity market performance, and the region remains exposed to risk on/risk off sentiment.


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