25 Sep 2014

Macro Strategy Update

Market Update and Portfolio Strategy

In our last market update we wrote that some form of monetary easing from the FED was to be expected, given the lack of substantial and sustainable strengthening in economic data. Well, Ben Bernanke surprised everyone with 'QE unlimited' - USD$40 billion (and more if necessary) of monthly mortgage bond purchases from the FED, aimed squarely at the domestic housing market, which has been showing signs of recovery.

The National Association of Home Builders Housing Market Index (Figure 1) has been improving, rising from 37 to 40 in August as confidence in housing sales rises. Housing prices, measured by the S&P Case Shiller index, has risen since the start of 2012 while the Home Builders equity index, a leading indicator of the sector, has been outperforming nicely and remains in a solid uptrend (Figure 2). This is clearly a sustainable recovery of the US housing sector.

Figure 1: NAHB Housing Market Index

Image courtesy of Stockcharts.com

Figure 2: US Housing Equities

Markets probably discounted the FED's move by sustaining the rally since June despite a slew of weak manufacturing data from around the world, including a deepening recession in Europe and a China grappling with slowing growth. Actions from policy makers have adjusted the market's perception of risk, as shown by several indicators. Cyclical equities continued to outperform while defensive sectors declined. TED spreads (Figure 3) and high yield bonds continue to show falling risk aversion. Economic sensitive commodities are rallying (Figure 4) while safe haven currencies are down. Hence, despite poor economic data, the message from markets is that risk taking is alive and is likely to continue for a while longer.

Image courtesy of Stockcharts.com

Figure 3: TED Spreads

Image courtesy of Stockcharts.com

Figure 4: Industrial Metals Prices

Some investors may have difficulty reconciling the current situation - markets seem disconnected with reality as equities are rising in the midst of poor economic data. However, investing based solely on fundamental or economic data is similar to driving and looking only at the rear view mirror since economic data, being at least a month old, provides historical information. On the other hand, market data is reflecting real time information and is an aggregation of millions of investment and trading decisions betting on what may happen in the future. It is thus a better predictive metric. But economic data is useful as they provide us with a confirmation of the market data signals. Coming back to the current situation where poor economic data seems at odds with positive market data, we would need to see a turnaround in the current weakness in the global economy if current market signals are to be proved correct. After all, central banks can only do so much.

Conclusion

Seasonal buyers may not get their way this year. Unless we get a major sell off this week, September is going to be another positive month for equities, marking the fourth consecutive month of a rising market and debunking the "Sell in May and Go Away" advice. Investors who are under-invested and under-performing fund managers will feel pressured to chase the market even as buying opportunities remain elusive. Bottom-line : We remain positive on risk assets for the time being. While we enjoy the ride in equities, we are watchful over the key risks that could derail the market euphoria.

Portfolio Positions

Although currently overweight in equities, we have just issued a recommendation to sell off some equity positions to lock in profits when we think the current market rally is starting to turn. Please approve the proposed switches as soon as possible and speak to your adviser should you have any questions.



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