Tuesday, December 4th, 2012

The Revenge of the Tea Party

The US election did equity investors no favours at all. It was as though the leadership of the Tea Party had set out to punish the US and the world for delivering the “wrong” result. US equities fell sharply as fears of budget deadlock prevailed. Since the middle of the month, investors have regained their nerve, expecting some sort of solution (probably not the best) to be delivered in the New Year. While all this was happening, the troika effectively decided to write off a large part of the Greek government debt (30 year zero-coupon bonds are worthless).

No matter what the reporting currency, the multi-asset model model has reduced its exposure to high risk assets by approximately 10% during the month, with the bulk of the reduction coming from emerging market equities. The big winner this month is investment grade bonds, which have benefited from the greater clarity emanating from the Greek negotiations. The asset class is heavily exposed to the financial sector and benefits every time the tail-risk of a banking crisis is reduced.

It is now four years since the anniversary of the TARP programme, the first official attempt to stabilise financial markets and the credit system. Since then we have grown used to endless official interventions in the workings of capital markets, many of them poorly designed and ineffective. All of these interventions have the capacity to alter the balance of risk and reward over the short term and can be disruptive to the  asset allocation process.  Year to date returns are -2%, which is disappointing, especially in the context of the strong recovery in risk assets from July onwards. At the time it was by no means certain that Mr Draghi’s promise to “do anything it takes” would be effective. Our decisions then meant that we lived to fight another day, but we failed to capitalize on the recovery. It could have been very different.

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