Prevailing odds

by

16 Jan 2013

“The Footsie’s broken 6,000,” observed my other half on the morning of 2 January in what I would argue is a not wholly representative glimpse into the excitement of my domestic life. “It won’t last,” I replied. “Plenty of institutional types will have programmed their computers to sell at that level so the FTSE will be back starting with a five before you know it.”

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“The Footsie’s broken 6,000,” observed my other half on the morning of 2 January in what I would argue is a not wholly representative glimpse into the excitement of my domestic life. “It won’t last,” I replied. “Plenty of institutional types will have programmed their computers to sell at that level so the FTSE will be back starting with a five before you know it.”

“The Footsie’s broken 6,000,” observed my other half on the morning of 2 January in what I would argue is a not wholly representative glimpse into the excitement of my domestic life. “It won’t last,” I replied. “Plenty of institutional types will have programmed their computers to sell at that level so the FTSE will be back starting with a five before you know it.”

As I write, 48 hours later, I am happy to admit I have so far been proved wrong. Maybe those institutional types – I dare say you know a few – forgot to programme their computers or, when they did, perhaps they were feeling racy enough to tap in 6,200 rather than 6,000. Maybe they are all still on holiday and things will get messy later.

More likely, it is linked to the fudge thus far achieved on the fiscal cliff – with markets expressing their relief after having apparently convinced themselves US politicians were really stupid enough to deadlock the US into losing four percentage points of GDP and millions of jobs – but I am hoping it might also be partly down to more investors realising what actually counts as risk these days.

Before Christmas, I spoke to David Fishwick, head of macro and equities investment at M&G Investments and co-manager of the group’s Episode Macro Fund, who – rather unseasonably – laid into economic forecasting. “When I began work in 1987, the starting point for all investment was econometric models,” he said. “However, it quickly became apparent to me that was flawed – both because you cannot be consistently better than everybody else at forecasting the economy and, more irritatingly, even when you have the economics right, often financial markets do something else.”

Instead, Fishwick takes as his starting point “the prevailing odds for assets”. “Essentially this means valuations set against some notion of history,” he explains. “Our outlook today is that, unless we head into a deflationary world, you now have a stark choice between capital preservation at all costs, which continues to tie you towards government debt – including a meaningful asymmetry between risk and return on longer-dated government bonds – and a more volatile profile. “If you want to buy what look like the only elevated real returns on the planet – that is, equity assets and the riskier end of credit – it will be an uncomfortable ride and, particularly over shorter periods of time, capital loss is potentially quite meaningful.”

With a degree of understatement, Fishwick describes this as “a challenging situation offering a set of reasonably stark choices” but adds: “At some point, the investment industry is going to have to recalibrate some of its views about equity correlation and about volatility being ‘bad’ and safety assets ‘good’.”

Just not yet though because, as Fishwick also notes, “the historical turn of the bond universe is still too strong to make people worry” so I am probably wrong with my earlier hope. Not for the first time in 2013, of course – and the year has barely even started.

Julian Marr is editorial director of Adviser-Hub and Thought Leadership Live and co-author of Investing in emerging markets – the BRIC economies and beyond

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