Market commentary: Deciphering current markets

Gone seem to be the days where the investment strategy was easy, where you would buy any American or European financial product (apart from commodities) and you’ll make money. Be it bonds or equities, all were making money and the strategy was very straight forward as the policy winds were in their sails and the market drifted along gently, making it seem all too easy for the average investor.

Sure enough, many retail investors boarded the money making ship which was the promise and implementation of QE which will inflate asset prices, and boy did it pay dividends.

As Isaac Newton had discovered a while back, eventually what goes up must come down. Although in financial markets that does not always hold proportionally true, when markets over-stretch themselves there is often a quick and unforgiving knee-jerk reaction which catches the passive investor by surprise.

Over the past couple of weeks we have witnessed this characteristic as many overly bullish investors were left somewhat surprised by the European economies’ positive reaction to Draghi’s policies and QE program. Sentiment appears to be changing, albeit it is still very early to claim victory as we require further, broader and more consistent data to claim that Europe is out of the woods.

Over in the U.S., for the past couple of months it has been a matter of when not if the Federal Reserve is going to raise interest rates, consensus leaning towards the end of September should economic data return favourable. The headwinds that appear to remain are the performance of the global economy, with China slowing down and Europe still buckling creating a damper on GDP growth expectations.

The result of this mixed and rather unclear environment is volatility. In Draghi’s press conference last Thursday the ECB president made it clear that investors should expect a period of volatility in asset prices. This in my opinion added more fuel to the correction, as volatility adds to the equity risk premium attributed to stocks, increasing the expected return on those assets in order to hold the stock.

Investors have started to question whether we have reached a turning point, and those early birds who begin to have cold feet, and want to lock in the handsome return they generated over the recent months to take a risk off approach and dump their assets, resulting in downward price pressure.

The current short term approach I am taking is also one which is risk off, underweight equities and bonds, which so far has proven successful since as anticipated the lack of clarity and difficulty in interpreting the markets is resulting in further downward pressure on asset prices as less people are willing to take on risk, also given that the summer months play a factor due to decreased volume and bids.

Going forward however, downside risks still remain as I expect the optimism following the increased momentum from the QE program to wear off and I still have my reservations whether the European economies can produce back-to-back improvements in economic data which is commensurate with justified changes in future inflation and interest rate expectations due to structural weaknesses inherent in the European economies which persist. Signs of this are the poor translation of QE funds to non-financial corporates which are the economic drivers in an economy.

One thing may be true however, it appears that European economies have bottomed out, and the probability of deflation is lower than a couple of months ago; therefore I find it hard to visualise bond prices reaching the levels they achieved last April. We surely have interesting times ahead, and I would retain some cash to take advantage of some over-played weaknesses.

This article was issued by Simon Psaila, Trader/ Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.