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Wednesday, 13 December 2017

Up, up and away…

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SwissInvest strategist Anthony Peters highlights that investment managers predict markets, not economies

Anthony Peters, SwissInvest Strategist

Not too many bods showed up in the office for the first half week of the new year and, truth be told, they didn’t miss much. Sure, there was a huge opening day rally on the back of the fiscal cliff vote but that was as predictable as night following day and I have seen similar early doors rallies when there was no issue of the US Congress backing the country away from the precipice. Anyhow, the debt ceiling debate awaits the unwary sometime in February and that will be another bundle of fun.

I don’t know how bored readers will be before long as they find themselves inundated with predictions and forecasts for the coming 52-week trading period. As far as forecasts are concerned, if they were accurate and reliable they’d be known as “onecasts” but they’re not and so they aren’t.

SOME YEARS BACK, I used to speak to an Austrian investment company that was managed by a very bright and innovative team – yes, Austria is not all boiled beef and strudel – which decided to compile a study by way of back-testing the accuracy of its counterparties’ long-dated currency forecasts and it came to the following conclusion: if they took the mean of all the forecasts, they ended up pretty much on the button of where the actuals eventually proved to be. On that basis, the best thing to do would be to collect as wide a sample as possible, calculate the mean and set long-dated forward hedges on that basis.

Undoubtedly, the hedging costs would be prohibitive and, anyhow, no self-respecting portfolio manager would care to admit that he could be replaced by working out the average of the forecasts of a bunch of analysts, all of whom were individually wrong.

SO, THE NEW year is upon us and off we go. The pipeline looks healthy and although there are doubts over the stability of underlying government bond markets – and I’m not referring to the ratings thing – credit should be well underpinned throughout 2013.

I have noted before that I don’t think that this will be the year when the fiscal chickens come home to roost as there is an air of optimism that we will somehow be able to grow ourselves out of deficits. To me, this is nonsense. When aggregate deficits exceed aggregate growth, which they have done more often than not in the past decade, then staring at GDP alone is of little use.

Congress has so far done little else than to convene in a private room, to create a new credit card company and then promptly to issue itself with a platinum card. However, if markets want to believe that all is well in the garden, then that is what one has to trade towards. Investment managers get paid to get the market right, not the economy.

Congress has so far done little else than to convene in a private room, to create a new credit card company and then promptly to issue itself with a platinum card. However, if markets want to believe that all is well in the garden, then that is what one has to trade towards. Investment managers get paid to get the market right, not the economy

I also have a feeling that the right way to go will be with consensus. There is a school that argues that the time to buy is when all surveys have investors bearish and that the time to sell is when it all looks unfailingly rosy. However, there is no law that confirms that the consensus has to be wrong. The biggest risks to markets are from unknown unknowns and although they are by definition unknown, we don’t seem to be entering 2013 with too many chances of major accidents. This ought to be a year where the political achievements of 2012 are consolidated and where the structural initiatives of the recent past are tested and fine-tuned.

CENTRAL BANKS HAVE next to no flexibility on the tightening side and even though the Fed has nailed its colours to the unemployment mast, it will struggle to move away from its near zero rate policy, even if the 6.5% trigger were to be reached this year. A 100bp shift in the yield curve would probably add around 1% to the deficit as about one-tenth of US Federal debt matures every year and … well, as the Americans say: “Do the math.”

But, to repeat myself, there are no surprises here and where there are none of them, there are as few significant risks. On that basis, the coming year should be in the clutches of the “risk on” brigade and, driven by momentum, equities will rally and with them closely correlated asset classes such as credit and loans will too.

AS SPREADS CONTINUE to compress, it will be hard for yield-hungry investors to resist the call of the CLO and I’d suggest that, before the year is out and subject to whatever regulatory hurdles may be thrown up along the way, the structured credit market will be firing on most of its cylinders again. The pursuit of yield has always fostered collective amnesia. And, as ever, the early entrants will make out like bandits and the timid who get sucked in at the late stage will be left holding the baby. But that, I’d venture to suggest, will not happen in 2013.

As spreads continue to compress, it will be hard for yield-hungry investors to resist the call of the CLO and I’d suggest that, before the year is out and subject to whatever regulatory hurdles may be thrown up along the way, the structured credit market will be firing on most of its cylinders again. The pursuit of yield has always fostered collective amnesia. And, as ever, the early entrants will make out like bandits and the timid who get sucked in at the late stage will be left holding the baby

Low risk years are great for high risk investments and if you’re looking for one of those, it’s quite possibly just begun.

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