Reflecting on the game of four quarters
Football might be a game of two halves but trading and investing is very much a game of four quarters. One down, three to go. Yesterday might have just seen us come back from a four-day weekend – what’s so amazing about that? – but it also marked the beginning of the second quarter of 2013.
Quarters, like financial years, are man-made constructs, accounting periods, which have little bearing on the real world but they do offer us a chance to reflect on forecasts and outcomes and, to be frank, the outcome of the first three months of the year has left many of us rather surprised.
The predictable bit was easy and performed to expectations. Equities had a screamer, credit spreads remained tight and… well, that’s where it all starts to go wrong.
Bonds were supposed to be the big loser and if you’d taken the measure in mid-February – if the year was split into eight eighths rather than four quarters – you’d have been bang on. Ten-year Bunds opened the year at 1.31% and by mid-February they were trading to form in the mid-1.60s.
However, the silent killer crept in and they closed the quarter at 1.27% and therefore in fact at a lower yield than where they had started. Easy, of course, blame the eurozone crisis.
Stop Press. Gilts opened the year at 1.83% for the 10 year and closed the quarter at 1.77%. Not the eurozone crisis this time but the double-dip recession. Incidentally, hasn’t the Chancellor, George Osborne, missed a trick in not pointing out to his detractors that since the UK was downgraded from Triple A, government bonds yields have fallen?
Well then, what about the biggest of all recovery stories, Uncle Sam himself? Even over the pond, despite the accelerating of growth and confidence story, the 10-year Treasury yield has risen by an eye-watering – check and query – 10bp from the year-end close of 1.75% to quarter-end mark of 1.85%.
Even the most cynical of bond bears would have to admit that, in the greater scheme of things, Treasuries were as good as unchanged over Q1
Incidentally, the January 1 closing price was 1.83%, so in a way we’ve gone next to nowhere. Even the most cynical of bond bears would have to admit that, in the greater scheme of things, Treasuries were as good as unchanged over the period as 10bp represents not a lot more than a decent one-day trading range.
Talking to one pension fund manager yesterday, we both concluded that fixed income did a lot better than either of us would have expected and certainly a good deal better than I had forecast three months ago. The question is, do we learn anything from this? Can we draw any meaningful conclusions from this performance which might assist us in our approach to portfolio positioning for Q2 or do we just hide behind the easy excuse of blaming the central banks for continuing to inject next to free liquidity into the markets?
The picture is certainly unclear. Although the VIX index is currently off its recent low of 11.05, it is generally at its best levels since 2007 – along with stock prices which are making new highs – so the “fear index” as the VIX is occasionally referred to, show no shades of red. Yet, strong performances by government bonds which are supposed to reflect the flight to quality would indicate the opposite.
Analysts and strategists who have been speaking of nervousness and uncertainty in the investor universe tend to be contradicted by being shown either the VIX or the relatively stable foreign exchange markets while bulls are asked why the guvvie yields can be so low if the picture is as rosy as they suggest. It looks as though people are being asked to dance in all camps at the same time. However, the argument that nobody knows what to do next can’t be right either or else asset markets would be falling and investors would be sitting on cash, pending new information.
Canaries in the coal mine
The fact is that the natural hedge in this liquidity-driven market is to be long of everything which, given the miserable situation in commodities – supposedly the canary in the industrial production coal mine – offer little support. On January 2, aluminium traded and closed on the LME at US$2,161.00/tonne but settled last night at US$1,884.00.
Copper, the purest of all of the industrial metals, was at US$8,254.00/tonne at the beginning of the year and it, in turn, settled at US$7,435.50 on the exchange last night. It is in fact at a six-month low and also not a million miles from its 12-month low of US$7,283.00 either.
The bubble economy of the last decade has burst and a new equilibrium is being found, albeit at a lower level of output and consumption
All in all, there’s a bit in there for everybody but still nothing in particular upon which a forecaster can truly hang his hat other than the knowledge that the monetary authorities might be talking of inflation risks but that they are scared of their own shadows, that they will not be tightening in the foreseeable future, growth or no growth, inflation or no inflation and that, irrespective of how yields or P/E ratios might be, you have to remain long financial assets.
However, what that does not do is to help us explain away the poor commodity prices – the CRB index as a whole is near as dammit flat since late October, wrapped around the mid-290s – so perhaps the argument should return to that long forgotten old chestnut, the square root recovery.
The answer, in reality is simple. The bubble economy of the last decade has burst and a new equilibrium is being found, albeit at a lower level of output and consumption. The figures speak for themselves but the political rhetoric continues to pursue the road which promises to lead to the land of milk and honey.
Strip out the talk, read the figures and feel happy that all is for the best in the best of all possible worlds while staying moderately long for another quarter.