As an investor, misunderstandings and overreaction can offer some of the best opportunities to profit. Here 5 widely held beliefs are challenged and attractive investment strategies revealed: There is no need to fear deflation; The stock market trade has reversed; It’s not too late to join the (small cap) party; Central Bank action will not achieve its goal; Turmoil in Ukraine unlikely to directly impact earnings…
Vitally important for being a successful investor is the ability to look beyond ‘buzzwords’, acknowledge that a wobble can be more dangerous when the training wheels come off and understand the nature of those that hold the future of the company / country / financial market in their hands.
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1. Catchy titles do not tell the full story (more…)
The room’s getting crowded, the party’s been going on a while but more people could arrive. Just beware fair weather friends and a sign it could be time to think about leaving…
Gemma Godfrey highlights the factors that could cause a pullback in markets and provide buying opportunities, on CNBC’s Fast Money. Published on cnbc.com by Bruno J. Navarro.
Market elation has been a little bit too early, moved a little bit too far, and there are these potholes that actually could cause markets to stumble, at least in the shorter term. Markets do not like uncertainty, and the longer this continues, the longer the uncertainty is over the markets, the more likely is it will have a pullback.
And it means when we’re looking at where valuations are , they’re no longer cheap with respect to the U.S. market, growth isn’t coming through as we thought it was going to come through, and you’ve got this level of uncertainty, meaning that it is more likely that these momentum followers – for example, the hedge funds are buying into financials – that they’re going to start to stumble.
But I do think that that means if we do see a correction, it could be muted because it’ll be a fantastic buying opportunity for those investors that are looking to rotate back into risk assets because over long-term, we’re actually more bullish about equities.
What the market needed was confidence and the return of depositors to put their money into European banks, something that hasn’t happened sufficiently.
All of that gives us slight cause for concern, meaning that we’re growing more cautious shorter-term, although, obviously, more bullish longer-term.”
And just a reminder of why Spain has been able to withstand bailout pressure and markets have shrugged off European woes until recently…
Gemma Godfrey, head of investment strategy for wealth management firm Brooks Macdonald, argues that the small drop in US economic output shows investors may have got carried away in recent weeks.
She warns that the stock market rally may prove fragile:
As investors dismiss the economic contraction to focus on the resilience of consumption, they miss the risk that this will come under pressure over the coming months as fiscal cliff measures come into play.
Market rallies have been driven by the fear of an imminent risk receding, but growth is now needed for another leg up in markets. Instead, the ‘pain trade’ is now missing out on equity upside, implying fear of underperformance may be driving investment versus conviction in the outlook for markets going forward. Exemplifying this is the recent rotation by Hedge funds into financial stocks, following the positive earnings momentum, which of course is backward over-the-shoulder looking, rather than based on confidence in the future.
After hitting multi-year highs, can the FTSE 100 continue its recent rally?
NO – The FTSE 100 has been rallying as the fear of risks, like a Eurozone exit or fiscal cliff stalemate, has receded. But growth is now needed for another leg up: there has been relief in the diagnosis, but the patient must now show signs of recovery. The concern for the UK is that it is tough to see a possible source of growth, especially after the latest economic figures showed us courting a triple dip recession. Looking overseas – as many FTSE companies do – the outlook for growth is more encouraging. But troubles in Europe and the US are far from over, as the former grapples with fiscal and banking union, and the latter with delayed spending cut decisions. Equities may provide value over the longer term, but you will have to encounter heightened volatility – and a likely correction – in the immediate future.
Central banks are running out of steam as their measures to bring calm back to markets are no longer as effective as they once were. Germany too seems unable to keep up. Like a marathon runner caught in a sprint, their reluctance to move forward stands in stark contrast to market moves focused on the end game. But the road isn’t clear. Europe has three remaining hurdles in their race to recovery: funds, fiscal unity and reform. With Greece approaching the final whistle, doubts over its ability to stay within Europe are growing louder. The worry is investors are watching the referee not the striker, more focused on the search for safety than the rising risk elsewhere in the markets. False starts continue to drive market volatility and while investors ask whether it’s time to back the ‘underdog’, European stocks may provide diamonds in rough, but things could get rougher.
Central Banks: Running out of steam
The vital relationship between central banks implementing stimulus and Spanish yields falling has broken down since April of this year. No longer is central bank action able to reassure the market and instead Spain and Italy’s borrowing costs remain at elevated levels. Investors are demanding more. Structural change is needed but markets are concerned that leaders could choke under the pressure.
Germany: A marathon runner caught in a sprint
Germany wants to progress towards greater unity at its own pace but the markets move faster. Indeed a backbencher delivered his dissatisfaction with the European Central Bank’s plans to their Constitutional Court! It will be tackled in September but investors and the economy won’t wait. Weak consumer confidence and rating agency scepticism highlight the urgency for action.
Europe: 3 Hurdles in Race to Recovery
The three key obstacles to be tackled to progress towards stability are: enough funds to contain the crisis; fiscal consolidation (share budgets in order to share debt burdens and be able to offer ‘eurobonds’); and finally structural reform to regain competitiveness & growth. All are vital for the future of the region and this realisation is starting to build within the markets. Europe did manage to overcome their concern that a Fed-Style straight bond buying programme would reduce the pressure on countries to reform, with a Memorandum of Understanding putting these measures on paper. The use of ‘MOU’s in order to accept ‘IOU’s to lend to countries within Europe may be a step forward, but this remains only part of the full picture needed for longer-lasting results.
Greece: Approaching the Final Whistle
S&P ratings agency has questioned whether Greece will be able to secure the next tranche of bailout funds as it downgraded the outlook for its credit rating to negative. Without such funding, the ‘death knell’ for Greece’s euro membership will be sounded. With the IMFsignalling payments to Greece will stop, the lack of funding fuels fears that without drastic action, the end could be near. Even beyond Greece, the Italian Prime Minister dared to publicise the possibility of a Eurozone breakup if borrowing costs did not fall.
Investors: Watching the Referee not the Striker
The rush to safety has been overshadowing rising risks. As investors pile in to perceived ‘safe haven’ assets, the yield on German government bonds has been falling. However, in a different market, the cost of insuring these bonds has risen as these investors see risk on the rise. The snapback in bond markets to better reflect this sentiment could shake the equity market as well and is therefore a significant concern.
Markets: False Starts
Markets have rallied in the face of disappointing data. Eurozone stocks reached a 4 monthhigh as manufacturing dropped to a 3 year low suggesting the slump is extending into Q3. This discrepancy has driven market volatility, exacerbated by the low volume of shares traded over the summer months. Greater clarity is required to see a more sustained upward momentum which will have to wait until leaders are back from their hols!
Investments: When to Back the Underdog?
European stocks may provide diamonds in rough, but things could get rougher. The overweight US / underweight EU trade is starting to look stretched, as the divergence in performance between the two regions continues to increase. This has been quite understandable, but there will come a time when this is overdone. Within Europe, there are international companies, with geographically diversified revenue streams so not dependent solely on domestic demand for their products or services. Furthermore, with effective management teams and strong fiscal positions, some may be starting to look cheap. However, cheap could get cheaper. Damage to sentiment could lead to market punishment regardless of fundamentals. Therefore waiting for decisive developments & clarity on road to recovery may be prudent.
The classic “safe-haven” investment has seen a strong uptrend in its value since the autumn of 2008. Risk aversion, inflation fears, falls in the dollar and demand from the east have all been credited as drivers of this move. But just how supportive are these factors going forward — what is the risk gold could lose its lustre?
A Hedge against Inflation
The fear of inflation is heating up as on Wednesday the Bank of England suggested that “there is a good chance” inflation will hit 5% later in the year, far above the target rate of 2%. Elsewhere, on the same day, Chinese inflation figures surprised on the upside. However, is gold an adequate hedge? It can be shown graphically that it is not. Charting the inflation rate (CPI change year on year) against the gold price, we can see that over the past decade the relationship breaks down. Indeed, if the gold price kept up with increases in general price levels, it would be valued at $2,600 an ounce instead of around the $1,500 level. How about if instead of actual inflation, we look at the market’s expectation of inflation? Even in this case, the relationship does not hold. Instead, there are other factors at play. As previously discussed, investors may be more focused on the sustainability of the economic growth rate and allow for some inflation. Inflation alone may not provide sufficient support.
A Beneficiary of Risk Aversion
So — could upcoming economic, fiscal or political disappointments sufficiently boost the gold price? Here the case looks stronger. From sovereign debt crises in Europe, to the tragic tsunami in Japan and the turmoil in the Middle East, there has been enough newsflow to stoke fears and flows into gold (a “whopping” $679m of capital was invested in precious metals in one week alone at the beginning of April). Furthermore, a lack of confidence in the dollar further boosted investment for those looking for a more reliable base.
Demand from the East and Central Banks
In addition to jewellery demand, central bank purchases may provide much support for gold as we move forward. Russia needs to acquire more than 1,000 tons and China 3,000 tons to have a gold reserve ratio to outstanding currency on parity with the U.S. This is even likely to be an understatement with China stating publicly they would like to acquire at least 6,000 tons and there are unofficial rumors that this may go as high as 10,000 tons.
A bubble with no clear end
George Soros described gold as the “ultimate asset bubble” and with sentiment driving the price as much as fundamentals, it’s unclear when the trend will reverse. An increasing monetary base is looking for a home. As Marcus Grubb, MD of Investment at the World Gold Council was quoted as saying at a ‘WealthBriefing’ Breakfast on Thursday: “In the next 10 minutes the world’s gold producers will mine $3m of gold, while the US prints $15m.” However, an often-overlooked drawback in investing in gold is its lack of yield. With some stock offering attractive dividend yields and investors wanting their investments to provide attractive returns during the life of their investment, capital flows may wander.
The Investment Insight
Remain wary of relying on one driver of returns; it can often be overshadowed by another. Instead build a complete picture and continuously question your base case scenario. Gold is a more complex asset than many give it credit for and as always, it pays to be well diversified.