"It has been a long time since the mood of global markets has been as buoyant as is has been in January 2013. Risk assets, such as equities, have rallied sharply in the first few weeks of trading and the prices of overbought ‘safe haven’ assets have started to fall. If history is a guide, such a start to the year augurs well – if US and UK equity markets enjoy a positive January, then historically, they go on to enjoy a positive year 82% of the time*. Inflows into riskier equities and higher yielding bond funds have been very robust as the global pressure to move out of low yielding cash assets in search of higher returns proves irresistible.
The rally has been gathering strength for some time, but we have only seen an acceleration in prices during the last few months. In bigger picture terms, nothing much has changed in terms of common global macro risks, such as high levels of debt or political wrangling. But what has changed is the perception that these risks are smaller than they have been for a good few years, despite easily retaining the capacity to derail the current uptrend.
There are good reasons for this change in perception, as we have been articulating since last summer. Namely a pick up in ‘leading indicators’, or put more simply, predictions by leading professional forecasters that things will improve soon. We are therefore now entering a very interesting ‘test phase’ in markets where fundamental reality (i.e. profit and growth numbers) have to improve in order for the rally to continue. In economic terms, we are waiting to see if the steady recovery in ‘leading indicators’ will morph into real economic growth, or fizzle out. We try to illustrate how important this could be, given how far equity markets have run and how sluggish the economy currently is, in more detail in the section at the end of this note.
The portfolios performed well across all mandates in January. Unsurprisingly, the long equity focused positions did very well but we were also pleased to see strong contributions from our non-equity positions and from asset allocation. Specifically the positions in Asian real estate, held via Macau Property, and our exposure to the global listed private equity arena, were very strong performers (+11-12% on the month). Both positions were originally of interest to us because they were trading on a big discount to their intrinsic value. Even after a strong January they still retain this attraction. We did take some profit in both positions after such a strong run up over such a short space of time, but we would describe this as sensible housekeeping rather than any indication of a reversal in trend. Similarly, our relative overweight in European equities worked well, and we have also trimmed exposures there to lock in some profit. Our current views are indicated in the summary table above entitled 'Table One'.
Expectations versus Reality
We mentioned in the opening section our view that markets are now entering a ‘test phase’, where we wait to see if the recent rallies can be supported by economic growth. The graph below illustrates this point by plotting the scale of outperformance of the UK stock market (in black and rising sharply) versus the scale of positive surprises in current UK economic data (in red and now turning negative). The next leg of market performance depends crucially on whether expectations for future economic news are better than the current reality.
(See 'Chart Two' at top of page)
Source: Bloomberg plot of FTSE 100 and Citi UK Economic Surprise index last 12 months
*Source Fidelity International and Goldman Sachs research.
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Investments do not guarantee a return and the value and the income from them can fall as well as rise, may also be dependent upon foreign exchange movements and be in relatively illiquid markets or instruments. Information on past performance, where given, is not necessarily a guide to future performance."
Saltus Partners LLP, February 2013