Iveagh’s Chris Wyllie says it is a risky time not to be invested
Chris Wyllie, chief executive officer at Iveagh, says that with investor psychology turning a corner and confidence increasing, it is a risky time not to be invested.
As soon as the American presidential vote was in, the market voted with its feet, falling 5% in seven days. Bruising as this may have been for Barack Obama’s ego, it was less an assessment of his competence as a rush to lock in year-to-date gains before the Battle of Fiscal Cliff began. However, history shows that markets often rally once feared wars actually start (hence “buy on the sound of cannons”), and so far this has held good in this case, with markets firming up since the two sides engaged. As a result the S&P index finished the month 0.3% higher in sterling terms, although it did lag other international markets (the MSCI World rose 1.1% by comparison).
The great worry has been that the American politicians will remain in deadlock and automatic tax hikes and spending cuts will plunge the economy back into recession.
This is not a path one would choose to take, and markets would likely react violently, at least in the short term. However, we have already been dogged by months of uncertainty, and this is beginning to show itself in some notably weaker survey data of late (for the first time since the summer). Clearly companies are pulling in their horns because they don’t have a basis on which to plan.
The good news is that this means there should be some potential energy stored up in the economy which will be released when we finally get a fiscal deal. This will help to offset the impact of the austerity which is in store, come what may. Therefore, perhaps the most destructive path is not necessarily the one that takes us over the cliff, but the one which leads nowhere i.e. the American politicians go the way of their European colleagues, and kick the can down the road.
Whilst investors have had to temper their enthusiasm for the US, there have been signs of creeping optimism about Europe. There was a seminal moment on 30 November, when the year-to-date total return of the Euro Stoxx Index overtook the S&P500.
We’ve been overweight European equities all year so it’s pleasing to see this rather contrarian view come to fruition. We think this theme has further to run, with European equities having the potential to make up more of the still substantial underperformance of the World index during the last four years. This view remains primarily predicated on cheap valuation (particularly in terms of cyclically adjusted earnings), but there is also now support from momentum, with some key resistance levels broken and increasing signs of investors being forced to close underweight positions.
The economic fundamentals have yet to manifestly turn, but there have been striking developments in the peripheral sovereign bond markets, with the spreads over bunds tumbling. At one point the 2 year Italian bond yield fell back below 1%, near all-time lows and, importantly, the lowest since the Greek crisis broke at the beginning of 2010.
In typical fashion, we have had a setback in the last day or two prompted by the resignation of Prime Minister Mario Monti, and we will now have to see how lasting the damage from this will be. Nevertheless, the broader message from bond markets has been that a substantial corner may have been turned, which could lead to a virtuous circle of rising confidence leading to lower bond yields which support economic growth and further bolster confidence – a reversal of the psychology of the last two years.
In the very short term markets are almost impossible to read because of the dependency on the outcome of the fiscal cliff discussions. This makes it feel like a risky time to be invested. However, our process signals have been quietly pointing an improvement in underlying fundamentals, and we think this is being obscured by the political machinations. This suggests that it is a risky time not to be invested.
We remain at neutral risk (a 5 on our 1 to 10 scale), despite the political imponderables.