LONDON, 16 December 2002 — It is a familiar story for investors. They plunge into the investment market full of hope and at first they sit out difficult phases even though this often takes considerable courage and nerve. However, in the end they lose patience, throw in the towel and withdraw from the market at precisely the wrong moment.
This time our perseverance has been rewarded. Following the all-time low in October, the global equity market rose almost 15 percent by Nov. 8, a considerable out performance in comparison with bonds. It is important now to not get carried away and to keep a cool head. Given the enormous volatility, the likelihood of a setback on the stock market is quite high. This promoted us to react on Nov. 8, when we decided to respond quickly and to realize our gains by reducing the equity components.
There are good reasons for assuming that the equity market will take a certain time to “digest” the price gains realized over a short period.
The positive third quarter company results have already been published and not much more can be expected on the monetary side in the United States after the generous reduction of the interest rate by 50 basis points. A loosening of the monetary reins in Europe is due any time now. December forward contracts have already factored in a reduction of 25 basis points.
Interest is therefore likely to switch to observation of the macroeconomic indicators and chart technical indicators. As far as the latest macro-economic indicators are concerned, the signs are that economic growth will weaken and in the near future a whole range of poor figures will probably dominate the headlines.
It can there for be assumed that in the short term the equity market will be characterized by a sideways movement. However, downward movements cannot be ruled out and in view of the high volatility they are likely to be more extreme than in normal circumstances.
In view of these expectations, the equity exposure has been reduced as follows: 2.5 percent in the conservative portfolio, 5 percent in the balanced profile and 7.5 percent in the growth portfolio. This reduces the levels of risk for all types of mandate.
It can be assumed that we will be able to increase the equity exposure again after a short breathing space on the market. For these reasons, the funds released form the equity investments have been placed on the money market.
Apart from active observation of the macro-economic indicators, the study of chart technical indicators is very important in the present environment. The chart technical indicators were also a factor in the decision to reduce the equity component. The daily MACD (Moving Average Convergence Divergence) indictor sent a sell signal at the beginning of November. We subsequently decided to sell equity positions that are either highly correlated with the overall equity market (shares with a high “beta”) or those shares whose valuations seemed to high. The following stocks were therefore removed from our “Focus Portfolio”: 3M, Pearson and American Express. The decision to reduce the equity components is definitely based on short-term, tactical considerations. In the long term, we are upbeat about equity investments. Why? The valuation argument remains valid: Apart from a few isolated exceptions, the equity markets are still undervalued both in terms of the price/earnings ratio and the risk premium. Moreover we are also confident that the numerous monetary relaxation measures both in the US and Europe will lead to moderate but steady economic growth. Help will also come from fiscal policy, especially in the US, where the Bush administration is now backed by the Republican Senate. The long-term chart technical indicators point to a recovery following the October lows. Finally, it should not be forgotten that very many private and institutional investors are currently underweighting equities and sitting on substantial reserves of liquidity. This liquidity should speed up the recovery considerably.
On Nov. 13, Iraq accepted the UN Security Council resolution and agreed to allow UN weapons inspectors to enter the country. The oil pride has fallen by 16 percent since its high point of almost $30 in September. We do not believe that the current stabilization of the oil price is likely to last. As energy shares generally outperform the overall market when oil prices are rising, we have upped the energy sector from neutral to overweight. At the same time we are reducing the industrial sector from overweight to neutral. The industrial sector is particularly hard hit by capacity utilization figures, which have been falling for the past three months. We anticipate that profits in the industrial sector will recover very slowly during the low-key upturn.
In the current difficult climate, with volatility persisting and long-term trends difficult to discern, we consider it advisable to pursue a cautious bonds duration strategy and to stick close to the relevant benchmarks. For this reason the duration in Euro has been increased form 4 to 4.5 years, thus reducing the gap between strategy and benchmark.
This change applies only to new mandates and to portfolios where adjustments have become necessary because of money inflows or outflows. This decision was based on the fact that the macroeconomic figures from the euro zone are likely to remain weak. Certain European structural problems will not disappear overnight and Germany is now experiencing a recession. So there are good grounds for assuming that yields will be subject to a volatile sideways movement. This means that investors cannot realistically expect any large price gains, nor are they likely to suffer major prices losses. A slightly longer duration enables the investor to exploit the steepness of the yield curve to obtain a higher yield.
(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information)
