Marcus Svedberg of East Capital -
The current extraordinary situation on the financial markets is disliked by most. Many investors feel it's better to be safe than sorry. That, on the other hand, may for several reasons turn out to be the wrong call - not the least performance wise.
Investors are on the whole very bearish and are staying away from any asset that is deemed risky, while asset managers are frustrated that their fundamental analyses matter less than (the lack of) political action and sentiment. This extraordinary crisis mood has been going on a long time already, and there is reason to believe it will continue for some time to come. It is thus easy to be pessimistic, but the fact is that the last few months, as well as the year as a whole, have been rather good in terms of equity market performance, which is why it has been dubbed the most hated rally ever.
Defensive vs. aggressive positioning
So, how should investors and managers position themselves going forward in this extraordinary market situation? The predominant advice out there is probably that it is better to be safe than sorry, meaning that a defensive approach is to be preferred over an aggressive one. Put differently, capital preservation has become more popular than capital management. It is simply too costly to bet that things will be okay as the downside risks are perceived as too big. This approach is quite understandable, especially as everyone remembers the sharp corrections during 2008 and 2011, but it is so widespread and may turn out to be the wrong call performance wise. There is a saying that when everyone agrees, it's time to be contrarian.
Reasons to be optimistic!
But are there any good reasons to be optimistic? We think so. First of all, those that have been more bullish this year have been awarded handsomely, as most equity markets are in black year to date, while the most bearish have lost money by staying in cash (due to the inflation effect) or lending at negative interest rates to the German or Danish governments. The broad global equity index is up almost 8%, while the German stock market has rallied almost 20%. Now, previous gains are no guarantee for future gains. Sometimes the opposite is true, but valuations are still attractive and many investors have arguably missed out, so there should be room for further gains.
Secondly, the Eurozone crisis is far from solved, but we are slowly and incrementally moving towards a solution. It may not be an optimal solution and many things can still go wrong, but there is action, and most likely more action to come if things deteriorate. There are very little pre-emptive efforts, but lots of reactive policy responses, suggesting that there will be more rescues if needed, but not before it becomes really necessary. The recent statement by Mario Draghi, president of the European Central Bank (ECB), that the policy response will be enough, is illustrative of this.
Thirdly, some large institutions are buying. One of the largest funds in the world, the Norwegian Pension Fund, which manages $600bn, revealed in late August plans to increase the weight of equities to take advantage of the low valuations. The fund, which owns 1% of all ordinary shares in the world, is thus about to repeat the approach it took after the global financial crisis in 2008 (remember that equities outperformed in 2009 and 2010). Others are likely to follow suit.
Fourthly, the good news tends to be concentrated in the emerging world rather than in the developed world. The Norwegians acknowledge this as they are increasing their exposure to emerging markets, while decreasing the weight of Western Europe. Many emerging markets are still growing and are not heavily indebted. Emerging markets have to some extent been taken hostage by the problems in the developed world for the past two years, and should thus revalue once focus is returning to fundamentals. Also, emerging markets have only gained 4% so far this year, while developed markets are up more than 8%, which suggests there is room for the former to catch up.
The fifth and final reason to be optimistic is monetary stimulus. The ECB announced the start of their new bond buying programme in early September and the US Federal Reserve might announce new rounds of monetary stimulus later in September. The Chinese have already shown that they are willing to stimulate when their economy slows down more than expected and may very well do so again. When the central banks of the three largest economies in the world are standing ready to pump more money into the global financial system, there is reason to believe riskier assets will appreciate.
Equities have appreciated lately in anticipation of these measures and there is, as always, a risk of disappointment. This is not necessarily a call for investing in equities, but rather an encouragement to start questioning the predominantly negative view in the market. Equity rallies should not be hated, they should be embraced.
Marcus Svedberg, Chief Economist of East Capital
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