Uncertainty brings opportunity says SIG’s John Ventre
Skandia Investment Group’s portfolio manager John Ventre outlines how SIG’s mutli-asset funds are being positioned to take advantage of ongoing market uncertainty.
Markets have been pretty chaotic over the last few days based on three key issues, the potential for a US downgrade; fears that large bond markets like Spain and Italy will have difficulty issuing new debt; and on fears that the current soft patch we are experiencing in economic data is more than just mid cycle weakness and indicates that we are headed back into a recession
From my perspective, these issues bring opportunity not risk for the following reasons:
Firstly, it’s not news that S&P were going to downgrade the credit rating of the US. They gave congress an ultimatum which congress did not yield too, specifically with respect to increasing revenue (taxes).
The notion that people will sell US debt because of this action is misguided. The US is the world’s largest bond market and if you have a lot of money and you want to own government bonds then you have to allocate substantially to the US. Fixed Income benchmarks are also market capitalization weighted so the more bonds you issue the more benchmark hugging strategies need to allocate. Post the downgrade, US treasury yields are actually lower this morning (US 5Y @ 1.15% vs Friday close @ 1.24%)
Then we have the combination of the EFSF (the European Financial Stability Fund), when its use has been ratified by parliaments, and the ECB purchasing Spanish and Italian bonds in the meantime, should provide peripheral markets the stability they need.
In particular, the EFSF’s ability to bail out banks directly is very good news for Spain because if the Spanish sovereign doesn’t have to bail out its banking system then its Debt to GDP is one of the lowest in the Eurozone and one of the lowest in the developed world. Spanish and Italian yields have now tightened very significantly, and it looks as if stress in this area is on the fade.
Finally, I’ve been expecting the economic data to get cyclically weaker for some time and its one of the reasons why I sold down our equity overweight in late April of this year, moving to neutral. We went into this recent volatility in good shape and the thesis at the time was to use weakness in the economic data as an opportunity to buy back equity positions at attractive levels.
In my opinion, a full-blown recession remains very unlikely, particularly because of the presence of the emerging consumer in China and other areas. There are risks at the margin that US consumer and business sentiment is damaged by the ratings downgrade, but we need to make sure that we don’t throw the baby out with the bathwater – corporates are in good shape, generally with strong balance sheets and a lower than usual cost base, meaning profitability is good.
So how how our multi asset funds at SIG been positioned?
We’ve been reducing interest rate duration in portfolios. From my perspective 1.15% 5-year US treasury yields represent extraordinarily poor value. It’s hard to see treasury yields falling any further and the risks are certainly to the upside
Then we’ve been significantly underweight European equities for a long time but we’ve closed this bet now. European equities looks massively oversold and sentiment now cannot get any worse. While European policymakers continue to “fumble the ball”, at 8x forward earnings and 4x forward cashflows, their ineptitude looks in the price. This was funded by closing some of our very successful Japan overweight, and by increasing our US underweight.
Finally, we’ve started to buy into equities selectively when markets are very weak. Equity markets generally are very oversold, and while a couple of our trades look to have been a day or two to early in hindsight, in reality it is always going to be hard to buy at the absolute low. The strategy of using uncertainty to establish equity positions at compellingly attractive valuations remains a sound one in my opinion and the funds are able to benefit from this strategy because we have been keeping some powder dry for just such an eventuality.
John Ventre is portfolio manager at Skandia Investment Group.