Beware of strategists wielding rulers. Decent third quarter GDP numbers have sent analysts scurrying off to increase their forecasts. We see this all too often, forecasts derived from extrapolating the newest trend, ratcheted up or down according to the latest surprise without regard to the deeper fundamentals that will really drive the eventual outcomes. Here lie elephant traps for asset allocators.
The macro economic backdrop has improved, with encouraging pick ups in GDP in the likes of the US, Germany etc, if sadly not the UK. But this was always going to happen in the initial recovery stage; further out the many headwinds remain just as strong as ever and it is disingenuous to assume that because we have seen a bit of a bounce, the whole story changes.
Equity markets have risen dramatically - in terms both of speed and distance - since the dog days of last March when, let's remember, only a handful of battered contrarians had a good word to say for them. The bull market has been amply justified by the reality that for some the recession is indeed over. Corporate profits have rebounded and will improve further. Dividends are being restored and sometimes increased. Markets were grossly oversold at their lows, partly thanks to the dead hand of consensus, partly because a slide into the abyss was for a while a real possibility.
As the tide has come in all the boats have risen; just about every asset class has done well this year, spookily reminiscent of the high correlations of 2008. The positive correlation between real assets and financial ones, notably sovereign bonds, is unusual and ought to ring a few alarm bells. When this happens we tend to puzzle over what it all means and we usually conclude that if one asset class is getting it wrong it is the bonds. Irritatingly, it usually turns out that it is the bonds that were getting it right. Whether that observation is informative for the current situation is the real dilemma for asset allocation.
Equities have risen on improving fundamentals but in the face of widespread scepticism. Many have missed the boat and much cash remains on the sidelines. This alone is likely to push equities higher into the year end; with strategists becoming over optimistic it is probable that equities will over reach to the upside, as they usually do.
This does not make the bonds 'wrong'. Yields may back up as Quantitative Easing winds down but the outlook is still bond friendly. For the asset allocator, riding the equity trend still makes sense while latecomers continue to scramble aboard. A close eye on the exit and respect for what bond markets are saying will, though, be essential.
Peter Bickley is chief strategist UK at Deutsche Bank Private Wealth Management
