VACILLATING markets can be self reinforcing up to a point. Part of this is that cause and effect can become muddled in the doomsayer trade.
Wobbly stock markets, such as those still on display this week, electrify the usual suspects back into action, warning (again) of a now very familiar sounding economic apocalypse.
However, their very familiar warnings somehow appear more foreboding when wider markets are seemingly in agreement. If history teaches us to have at least some respect for the market’s ability to price the prevailing context correctly, what cause could we have to disagree now?
In a world where all available information is apparently incorporated so efficiently, why do we bother to do anything other than just show up with a diversified portfolio and let the markets do the rest? Why try to ‘beat’ the market as we and so many others do?
One potential answer was described in Lasse Heje Pedersen’s interesting exploration of the subject ‘Efficiently Inefficient’. In it, he argues that prices are pushed away from their fundamental values by a variety of demand pressures and institutional frictions.
Think of an investor selling bonds to pay for a wedding, or a pension fund trading purely to comply with new regulation or even an ever growing herd of investors buying or selling an asset for no greater reason than the price has been rising/falling. In such a market, money managers are in a sense rewarded for providing a service to the market, namely providing liquidity, or the ability to transact in that market.
It's important to note though that this degree of inefficiency is likely minor. In Pedersen’s, and others’ understanding, the inefficiency is sufficient for some money managers to be compensated for their costs and risks through superior performance, but also just efficient enough that the rewards to money management after all costs do not encourage entry of new managers or additional capital
We are often asked what we are doing in portfolios to combat this particular threat or take advantage of that potential opportunity. The frustratingly enigmatic response is always ‘it depends what has been priced in by the markets’. Even more frustratingly, how the market prices particular threats and opportunities is of course not directly observable.
At the moment there seems to be a disconnect between decent incoming economic and corporate data and the market’s reaction to that data. For sure, there can be legitimate reasons for such a disconnect. For instance, we could be a in a period of adjustment for investors who had simply priced too rosier an outlook into asset prices.
Our hunch remains however that this latest bout of market dyspepsia owes more to those still reverberating worries about what happens when the long fretted over global debt pile meets higher US interest rates. As we noted before, we don’t think we are at a choke point for either the US or indeed the global economy.
We think that sentiment has gone too far into the negative and would bet against that gloom. This is part of the reason why we continue to hold overweight positions in both developed and emerging market stocks in our current tactical portfolio, and why these overweight positions are still funded from a mixture of the more defensive areas of the world’s capital markets.
:: Jonathan Sloan (jonathan.sloan@barclays.com) is a director at Barclays Wealth & Investment.
