26 November 2014

Market Update

When the Wind Blows

Executive Summary: We expect markets, especially the US, to continue their slow rise up until year-end. Accommodative central banks and seasonal factors combine to provide multiple tailwinds to risk assets. Risk indicators appear benign and market breadth continues to improve following October’s risk-off period. We will continue to remain overweight in the US until the narrative changes.

Portfolio Positions: For clients on the gManaged portfolios, we have recently sent out a request to reduce our equity overweight positions to neutral and we expect to execute this by end-Jan 2015.


Looking Ahead.
With the volatility we experienced in October now in the rear view mirror, let’s look at some data points to assess the robustness of our narrative that markets will continue their march higher, aided by positive tailwinds. We also want to guard against complacency and check our leading indicators for signs of risk.

Central Bank Tailwinds.
Market participants need to worry about the end of US QE. Late last month, the BOJ surprised the market by unexpectedly increasing its own QE program, indicating their resolve in hitting the inflation target. Just last week, China’s PBoC continued its targeted easing measures by reducing its benchmark one-year loan rate providing a fillip to the market. ECB’s Draghi also managed to jawbone the Euro lower by stressing on the urgency to raise inflation expectations via a wide range of asset purchases. The moves by these various central banks should continue to provide liquidity to the market and support asset prices in the short term.

Strong US Capital Inflows.
In a world with zero-bound yields, there is currently no better place for investors to put their money than in the US. The stronger dollar, positive growth and economic prospects, and seasonal factors have all combined to result in a big uptick in private foreign investment (Fig 1). Such flows will continue to support the US stock and fixed income markets.

Fig 1: Strong Fund Flows Will Provide Support To the US Market

Improving Market Breadth.
We also see market breadth improving. More stocks are in a bullish trend, more are trading above their 200-day moving averages and more are making new highs. The underlying worry for us was whether the market would make new highs but driven by only a handful of big names. Even small cap stocks which are typically more exposed to domestic growth drivers and have been struggling this year, recovered nicely (Fig 2 & 3).

Image courtesy of Stockcharts.com

Fig 2: Following the Recent Correction, Large Cap Stock Breadth Is Recovering.

Image courtesy of Stockcharts.com

Fig 3: Market Breadth Improved in Small Caps Which is Bullish.

Financial Market Stress.
Some of the risk indicators which we track are settling back into low levels, indicating a benign environment with below-average financial market stress. Such low index levels in the past typically coincided with a conducive risk taking environment (Fig 4).

Fig 4: The STLFSI is Indicating a Low Financial Risk Environment.

The key takeaway from the market is this: investors continue to price in sustainable growth in the US despite deflationary fears in Europe and an economic slowdown in the rest of the world. Whilst we are cognisant that the US market is probably fairly priced for now which could limit its upside in the future, the uptrend remains intact and we should be overweight in the region until the narrative changes. Our views are reflected in our portfolio positions.

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