Rotating markets and politics
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Welcome to Uncommon Truths, Paul Jackson and Andras Vig’s regular in-depth look at the big topics impacting markets.
After a brief period of market volatility, it feels as though things have returned to where they were. However, though market indices have recovered, the great rotation (into value and small caps) that seemed to be starting in early July has not returned. A weak US economy may delay that rotation but Paul expects it to reemerge.
One pre-volatility trend that seems to be reasserting itself is the weakness of the Japanese yen (and strong performance of Japanese stocks). With interest rate spreads so generous (US versus Japan), Paul understands why carry traders are tempted to reopen those trades (effectively shorting the yen and going long dollar). Hence, yen weakness may persist but he suspects that once the Fed eases aggressively (and the BOJ tightens), the yen will appreciate a lot, which he thinks will hurt the relative performance of Japanese stocks (in local currency terms).
There has also been a rotation in US politics, with a reversal of the opinion poll lead of Donald Trump, as VP Kamala Harris replaced President Biden as the Democratic Party candidate. Paul warns that the opinion poll margins are too narrow to be confident of the 5 November outcome but he now feels more confident about his January Aristotle List prediction that Democrats will win two of the three big races (White House, Senate and House of Representatives). It is too soon to know if the recently announced Harris economic package will help. What seems clear is that fiscal consolidation is not a priority for either presidential candidate, which he fears could eventually be a problem for financial markets.
Catch up on the last few editions:
FAQs
The optimal portfolios are theoretical and not real. We use optimisation processes to guide our allocations around “neutral” and within prescribed policy ranges based on our estimations of expected returns and using historical covariance information. This guides the allocation to global asset groups (equities, government bonds etc.), which is the most important level of decision. For Uncommon Truths, the optimal portfolios are constructed with a one-year horizon.
We’ve chosen to include equities, bonds (government, corporate investment grade and corporate high-yield), real estate investment trusts (REITs, to represent real estate), commodities and cash, on a global level. We use cross-asset correlations to decide which decisions are the most important.
Using a covariance matrix, based on monthly local currency total returns for the last five years, we run an optimisation process that maximises the Sharpe Ratio. Another version maximises Return subject to volatility not exceeding that of our Neutral Portfolio. The optimiser is based on the Markowitz model.
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