Wednesday, March 21st, 2012

Multi Asset Model Commentary 21/03/2012

(This commentary was written originally specifically for the US Dollar Multi-Asset Model)

Market conditions

Last week’s sell off in US treasuries only confirmed what has been going in since late January. Having reached historically low yields, the long end of the US bond market is vulnerable to profit-taking. Volatility is clearly past its low, and unless there is some fresh injection of geo-political uncertainty, returns from US government bonds are likely to go sideways, or down, on rising volatility.

This automatically improves the outlook for risk assets. Here we see volatility falling or about to fall across the board. The volatility of US equities and REITS peaked in late January, and it looks as though the volatility of emerging market equities may be peaking now.

Current positions

The largest single position is accounted for by US equities, with corporate bonds and REITs as joint second equal. US government bonds now have the lowest weight in the portfolio since the market sell-off which began in late May 2011, and are the least preferred asset.

Emerging market equities were completely out of favour until early February, but the model is now rebuilding its exposure to this asset class at the rate of a few percentage points every week. Risk assets (equities and REITs) now account for some 65% of the total portfolio, up from just under 50% four weeks ago.


We stick to our view that REITs offer excellent long term protection against inflation, but for the time being investors are focussed on whether interest rates and bond yields can remain at their ultra-low levels through 2014 as Chairman Bernanke recently implied. The current verdict seems to be “No.” Rental growth in the US office market continues to be strong but capitalisation rates may come under pressure if bond yields continue to rise.

This sort of environment is normally more favourable to equity markets, and we would expect emerging and US equity markets to gain weight at the expense of REITs. Corporate bond markets are clearly preferred to US treasuries because of their lower volatility, shorter maturity and higher yields.

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