Investing in Global Financial Markets

8/9/2019 Investing in Global Financial Markets

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Source: Wall Street Journal

For other long term charts of U.S. indexes, check out the S & P Weekly Chart (1960 to Present)and theNasdaq Weekly Chart (1978 to Present).

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Historical Charts For U.S. Bonds

When reviewing U.S. bond charts, youll notice how bond prices are inversely proportional tobond yields, which means that they move in opposite directions. When bond prices go up, bondyields and interest rates go down, which youll notice in chart patterns.

Bond Yields Chart, Yearly (1938-2008)


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Source: Gold Speculator

30 Year Treasury Bond Prices (1978 2009, Monthly)

Source: StockCharts.com, the bond yield chart is plotted in red.

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Historical Chart For Gold Prices, Yearly (1975 2009)

Source: Kitco.com

Gold prices were flat for quite a long time after peaking in the early 80s. But it appears that thisasset class is seeing some better times, with current rallies taking it over $1,000 an ounce.Historically, gold does well when there is economic uncertainty and widespread worry in thefinancial markets, so its no surprise its doing so well right now as a safe haven for nervousinvestors. Its always a good idea to diversify your investment portfolio with precious metalssuch as gold, in order to neutralize the effects of lower equity prices during an economicdowntrend.

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Historical Chart For U.S. Real Estate, Yearly (1970 2009)

Source: Housing Bubble

The huge runup in real estate from the late 90s to the mid 00s has since been reversed to somedegree. Housing prices today are more in line with what they were in the early 00s. Whileforeclosures still abound around the nation, it seems that in many places, real estate prices havestabilized. But it remains to be seen what kind of returns this market will be yielding in the

future. I doubt well see again, the kind of unprecedented price increases in real estate that weexperienced over the last decade. Will we learn anything from having gone through this housingbubble?

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Historical Chart For The Nikkei Index, Yearly (1970 2009)

Source: Sharelynx.com

If you want to see the most frightening market chart of all, then look no further than thehistorical chart for the Japanese Nikkei index. The performance of the Japanese market shouldserve as a lesson to all investors that not all markets reward us with a long term upward trend.The serious excesses in the late 80s have done a lot of damage to the Japanese economic systemand to this day, their stock prices have never returned to the heights experienced two decadesago.

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Historical Chart For The China Shanghai Composite Index, Yearly (1991 2009)

Source: Sharelynx.com

It wasnt just the U.S. stock market that deflated late last year so did the Chinese stockmarket, as represented by the Shanghai Composite Index. But as you can see, its tremendous,meteoric rise in 2007 just did not seem sustainable. At this time, I see equity prices meanderingat more reasonable levels, albeit having recovered along with the U.S. market indexes.

Here are additional observations Ive made on the recent behavior of various investment marketssuch as the U.S. housing, U.S. stock and international equity markets: there appears to be anoticeable correlation between them as far as how prices have trended over the past few years.This goes to show us that certain markets may be much more in lock step than we may think. Itsimportant, therefore, to keep our portfolios well diversified in order to accommodate many assetclasses, particularly less correlated ones (such as equity vs gold vs commodities). This willactually help us manage our investment risks better.


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Global financial markets and investment outlook by FC Ivestments. 3rd Quarter 2009

Global equity markets posted an encouraging recovery in the second quarter. Share prices moved ahead as

investors sensed that the fiscal rescue funds injected into the worlds economies were succeeding in slowing the

recessionary spiral.

For the most part, however, hard economic data failed to support the resurgence of sentiment and by June the stockrally had petered out into consolidation. Underlying concerns over the high issuance and rising inflation depressed

government bonds and they underperformed equities. One of the main developments during the quarter was

continuation of the sharp run-up in commodity prices. Oil rebounded to around $70 a barrel as expectations for global

demand rose, but remained well below its $147 high of July 2008.

While still brittle, sentiment towards US equities was bolstered by some better-than-expected data on inflation,

manufacturing and new housing starts. Indeed, this increasing optimism, which was mirrored by an improvement in

consumer confidence, prompted the Federal Reserve to forecast that the American economy would return to growth

by the end of the year. The US government continued to table expansive policy responses to the recession over the

quarter. The Public Private Investment Programme made available $1 trillion to repurchase troubled bank assets and

restore confidence in the financial system. The more robust mood was tempered, however, by the filing for

bankruptcy protection by the car giant General Motors, a collapse which represented the biggest failure of an

industrial company in US corporate history.

Continental European equities made strong progress, despite there being few tangible signs of the region

emerging from the economic doldrums. Data releases from the first quarter confirmed the depth of the recession, with

a slump in exports causing Germany to suffer its worst contraction since re-unification in 1990. However, while

unemployment rose to a ten-year high, there were indications that the economy was bottoming out in June as

manufacturing and services posted their lowest rate of decline in nine months. Moreover, the quarterly company

reporting season, while containing a number of disappointments, seemed to suggest that earnings had broadly

troughed. In April, the European Central Bank, which had been behind the curve in terms of monetary easing, cut

interest rates to 1%.

The UK market strengthened in the second quarter as bombed-out financial stocks began to regain their poise. News

on the economy was nevertheless mixed, with the boost to sentiment of better-than-forecast industrial production

data and a brighter outlook for the housing market being moderated by rising unemployment, faltering retail sales and

a record budget deficit. During the quarter the UK government instituted quantitative easing, a reflationary policy

designed to inject capital into the broader economy, not just the financial system. The move was well-received and

helped the currency post a recovery, with the pound reaching a six-month high against the euro in June.

Japanese stocks were buoyed by signs of improving exports, although the jobless rate climbed to 5%, the highest

rate in five years. The release of data showing growth contracted by an annualised 14.2% in the first quarter painted

a bleak picture of an economy whose prospects could be further blighted by the return of deflation; prices fell by a

record year-on-year rate in May. Elsewhere in the Far East, the Chinese governments stimulus spending helped lift

domestic demand amid a severe export slump, leading to expectations of a return to robust growth in 2010.

Emerging markets, with their high cyclicality, were the main beneficiaries of the upswing in investor sentiment.

Resources exporters such as Brazil and Russia reaped the benefits of rising prices and strengthening demand, whilethe re-election of a market-friendly government also drove Indian stocks sharply higher. While the global economic

cycle seemed to have stabilised, some markets continued to contract, with Africas largest economy, South Africa,

officially falling into recession over the quarter.

Global government bonds struggled in the second quarter as concerns over burgeoning budget deficits, surging

issuance and rising longer-term inflation exerted upward pressure on yields. Corporate debt nevertheless made

solid absolute returns as investors took heart from generally encouraging company profits. High yield bonds rallied

particularly hard on the back of extremely cheap valuations and revised expectations for default rates.


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Indeed, such is the power of sentiment that when global share prices posted their surprise spring rebound, Paul

Niven, F&Cs Head of Asset Allocation, was led to comment, Markets have shown they are capable of rising on no

news or even what on the face of it appears bad news.

One of the principal motivations behind diversifying is that all of your holdings will not fall at the same time. Declines

in one class will be buffered by gains in another, or at least lesser losses in others. This effect has not provided much

of a buffer since the summer of 2008.

The correlation of stocks, as the relationship of their performance across the market is termed, is normally highest at

times of major crises of sentiment. The panic that gripped investors in the wake of the stock market crash of 1987

and the terrorist attacks of September 2001 are prime examples of extreme risk aversion stampeding over

fundamentals.

The current very high levels of correlation have not been triggered by a single event but by the lingering uncertainty

over the most likely outcome for the global economy. The dominating question has been whether we are to expect a

steady, if tepid, recovery or a painful slide into depression.

Behavioural factors are driving stock returns across markets, with investors responding herd-like to data releases

supporting either scenario. Stock specific news has been largely irrelevant and, remarkably, this has even been the

case during the latest earnings season, when individual company newsflow should be at its height. Getting theindividual names right in the portfolio has hardly ever been less important.

This backdrop has represented a window of opportunity for momentum investors who tap into behavioural biases by

waiting for a trend to be established and then buy or sell in the hope of that trend continuing. For many market

participants, there is considerable comfort in following the pack, but heavy losses can punish those who get greedy

and hang on too long.

F&Cs team of quantitative analysts has observed that high correlation levels have been present in the markets since

as far back as 2004, a period through which even the best fund managers have found it hard to stand out from the

crowd. As a professional investor, just about the only factor to differentiate your performance in the last five years or

so would have been the scale of your exposure to the gyrating commodities market.

The good news for quantitative analysts and, indeed, investors relying on traditional, valuationbased methods is that

correlations are starting to settle back down to historical levels, thereby providing a higher benefit to strategic asset

allocation once again. The current low prices and the high implied volatilities of many stocks will allow selective

investors to lay the groundwork for a substantial boost in portfolio performance.

When good companies are treated by the market as though they are just as risky as bad companies, there is an

opportunity for long-only investors to pick up the good ones at very attractive prices. Furthermore, even though

correlations between indices have increased considerably for the time being, it is still possible to find groups of stocks

that exhibit low correlations to one another, thereby providing increased diversification benefits.

Europe-based investors may wish to consider, however, that it may be necessary to look much further afield to find

the best stock specific risk. By comparison to Japan and the US, the UK and European markets are narrower, more

mature and with much lower levels of turnover.

In the quantitative environment, where the availability of sophisticated modelling software is bringing down barriers to

entry every year, it is those operations with the scale and research power to identify new and unique methods of

identifying value that stand to generate the best returns. The concept of the small boutique that gears itself into the

intellectual capital of one or two individuals may accordingly start to wane in influence.

Scale and resources will be an issue for traditional long-only fund managers too. The necessity to cut costs in

response to sharply lower markets has prompted many investment organisations to cut their research capabilities to


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the bone. As stock market correlation declines, it will be those companies that have retained the ability to carry out in-

depth bespoke analysis that will be the best placed to sift the winners from the losers.

The transition of the market from being technically driven to fundamentally driven is imminent. When this occurs, the

resurgence of predictable valuation factors, such as earnings and cashflow, may arguably give active investors their

best opportunity since the demise of the technology boom. Research has shown that momentum investing can still

thrive when correlation levels normalise. However, with history suggesting that intervention by the monetaryauthorities habitually results in a further asset bubble, sound, old-fashioned company analysis is primed once again

to deliver the most reliable long-term rewards.

Current strategy

Despite the significant rally seen across markets, we still stand some way from pre-Lehman levels across asset

prices and economic indicators, which is being seen by some as a bullish precursor to a normalisation of market

conditions. Our view, however, is somewhat more cautious in the near term and we feel that investors may now be

too sanguine on the outlook for the economy and the risks that remain prevalent. While we continue to favour equities

over bonds, the scale of our overweighting has therefore been reduced.

We would certainly take the view that the economic and corporate backdrop is significantly more positive today than

at any point since Lehman Brothers collapsed last September. Nonetheless, having been underweight equities for a

large part of 2008, and overweight through the rally, we think that positions on risk should begin to be reined in.

US equities now trade on 15.5x trend earnings, just below long-run average levels, and credit markets have moved

from pricing in defaults consistent with depression to a situation more consistent with severe recession. There is

certainly enough of a valuation gap in equities (particularly outside of the US) to warrant the expectation of good

longer-term returns both in excess of cash and government bonds, but we are a long way from the unconditional

value offered just two to three months ago.

In contrast to equities, credits and commodities, government bonds have struggled. Yields have backed up as

inflation concerns have resurfaced, supply of paper has ballooned, creditworthiness of issuers has been undermined

and the economy has returned from the dead. Here, however, bond markets are looking more interesting to us. We


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do not dispute that long-run valuations are poor and are certainly mindful of the inflation and rating risks associated

with government bonds, but we feel that economic disappointment, ongoing risks of deflation and a likely desire of

authorities to cap the rise in yields (which could derail recovery) will help yields down in coming months.

Within markets, we continue to favour emerging markets and are negative on Europe and the US. We are reversing

our long position on UK equities, partly in response to the rapid rise in sterling. While we expect the dollar to weaken

over the longer term there is scope for outperformance of overseas assets in sterling terms and the UK equity marketnow has no clear relative attractions on an unhedged basis.

Our view, then, is that we are close to the end of the bear market rally. History shows that such rallies can be huge,

although it is rare to get one as explosive as we have seen in such a short a period of time. From here, with valuation

broadly fair and limited scope for upside surprises in economic and corporate newsflow, we see the risks on equities

and credits as much more finely balanced.

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Investing in Global Financial Markets