Tuesday, December 9th, 2014

It’s Too Darned Quiet.

Newspapers love change. Without it they have nothing to say and people have no reason to read them. Investment research is different. Sometimes nothing happens, and nothing changes. Sometimes a lot happens, but everything seems to cancel out everything else and there is no need for investors to alter the positions. We seem to be at one of those moments now. The headlines are full of falling oil prices, the possibility of a “massive” intervention by the ECB, surging payrolls in the US and a looming “crisis in emerging markets”. But all our models produce is a set of lines that go sideways.

Our US asset allocation model has barely moved over the last four weeks. The split between equities and fixed income has varied by less than 5% in a month, a figure which is well within the normal weekly change. The equity portion remains dominated by the position in US equities; in fixed income our holding of US Treasuries is within 2% of where it was four weeks ago. All of these differences can be accounted for by underlying market movements and do not represent a change of view. It’s the same story for our sterling and euro denominated models – high and stable exposure to fixed income markets mostly in the form of medium-dated government securities – low and stable exposure to equities, mostly in the US, with modest reductions in emerging markets offset by equally modest increases in Japan and / or the Eurozone.

Our sector models show an equal lack of the excitement. In the US there has only been one change to the composition of the top three sectors over the last month, and one change to the composition of the bottom three. In Europe there is one change to the top three and none to the bottom. For Japan the numbers are three changes to the top (which is slightly above average), but only one to the bottom. If this were a Hollywood Western, the sergeant would turn to the officer leading the patrol and say, “I don’t like it, sir. It’s too darned quiet.” Whereupon he would be shot with an arrow and the Indians would come charging out from behind the rocks.

Self-cancelling news stories are clearly part of the current situation. Thus, the blow-out payrolls number last Friday brings with it the fear that the Fed will bring forward the first interest-rate hike. In Europe the fall in the dollar price of oil, is offset by the fall in the euro vs the dollar. Either story on its own would provide investors with a clear course of action – buy exporters for the falling euro, and consumers for the oil price. Both happening together is a marvellous excuse for inaction.

And yet it feels as though something else is at work. It could just be the seasonal unwillingness of investors to commit to new positions so close to the year end. We may have reached a point in the market cycle where investors just can’t work out what to buy. Whatever the explanation, this situation is unlikely to continue for very long. Something is bound to happen and markets will suddenly kick back into action.

The issue we notice is the sudden uptick in unscheduled elections, first Japan, then Sweden, then Greece. Who knows what effect a bout of political instability could have? One day events will have consequences again and investors will be forced to react.

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