In Who Wants to be a Millionaire? contestants receive three ‘lifelines’: phone a friend, 50:50, or ask the audience.
In asset management these are also available: phoning a friend and 50:50 are self-explanatory, while asking the audience is using the market to tell you what to do (contrarian/momentum).
Professional investors, perhaps arrogantly, tend to spurn ‘lifelines’ backing themselves to answer the market question correctly, given their fundamentalist backgrounds. However, as even the great Warren Buffett notes there can be times when it is useful to use one of these lifelines: “Be greedy when others are fearful and fearful when others are greedy.”
After the volatility of May and June, we sit at an interesting crossroads with the balance between macro and micro finely poised. Solid corporate fundamentals provided support for the micro camp in the first quarter of this year, while the second quarter was dominated by macro themes with sovereign risks taking centre stage. In the Buffett mantra, we have been opportunistically greedy this year adding risk in February’s correction while buying insurance (puts) in late April.
Today, our bottom-up fundamental analysis finds more value in equity assets (particularly the developed markets of the UK & US) relative to sovereign fixed income assets, as epitomised in the UK by the FTSE 100 dividend yield being higher than 10-year gilt yields. Despite this apparent value being left on the table, the ‘audience’ has become more fearful, continuing to move into less risky assets as concerns about a ‘double-dip’ recession have emerged caused by the sovereign debt crisis.
Double-dip recessions are rare; essentially there have been two in the last century, 1931 and 1981, both caused by interest rate policy errors when central bankers raised interest rates too early or aggressively. With interest rates near zero in developed economies and no sign of early or aggressive increases, those mistakes appear unlikely to be repeated. However, ‘double-dippers’ also argue sovereign debt burdens and sharp cuts in public spending are the policy errors this time around.
Looking at the UK, the bond market has taken comfort from the clear policy action taken in the emergency Budget. While public sector spending cuts may grab audience headlines in the short term, the coalition has provided stimulus to private sector employers to invest with national insurance and corporation tax cuts each year for the next four years. Time will tell whether the double-dippers are right, and at the moment the ‘audience’ is trying to decide whether we are going to repeat the autumn of 2004 (recovery) or the autumn of 2008 (Lehman).
Piers Hillier is CIO at LV= Asset Management
