«Drowning appears an appealing alternative to those dying of thirst.»
(Kathrin Bärbock, German philosopher)
Do you know Tina? No, she’s not the next US President or the main character in the latest docu-soap. Tina is, in fact, an acronym for «There is No Alternative». Although the term was coined by the English philosopher Herbert Spencer, it was made famous by UK prime minister Margaret Thatcher, who believed that there was no alternative to the market economy.
More than three decades on, Tina has become the new buzzword of investors who believe there is no alternative to equities. But caution is called for whenever new buzzwords, paradigms or mantras enter the vocabulary of the financial world. At various defining points of recent economic history, investors have been under pressure to ride the latest wave of speculation, be it the arcane structure of equity funds in the 1930s, the silver squeeze of the Hunt brothers in the 1980s, the innovative speculation and hedging instruments of 1987, the ties between companies and the internet during the dot-com bubble, or the abstruse structure of mortgage lending during the most recent financial crisis.
In the last quarter, traditional bond investors were squeezed out of the markets by the central banks. These more conservative investors sought comfort in the equity markets, since they still had a regular income in the form of dividends. As a result, most bond indices gained almost no ground, while equities continued their recovery. Equities were seen as a profitable alternative to bonds, where yields were in negative territory or barely above zero.
In the past, investors bought bonds that offered a steady income for peace of mind. They deliberately refrained from capital gains. Today, the same investors are buying equities that pay regular dividend income, and holding bonds with negative yields merely in the hope of a capital gain. Equities are currently being bought by both risk-taking and risk-averse investors, simply because there is no alternative – in other words, Tina.
«Don’t fight the addiction, live the alternative!»
(Ute Lauterbach, German author)
A prerequisite for the functioning of modern portfolio theory – for which Harry Markowitz received the Nobel Prize in economics in 1990 – is to hold alternatives in the securities portfolio: alternatives with different, mutually compensating price trends should guarantee the stability of the portfolio and increase its long-term value.
Although based on data from past decades, what was valid in the 1990s gradually lost some of its significance as the international financial markets became more interconnected. Since the dot-com bubble burst in the spring of 2000, and particularly since the outbreak of the financial crisis eight years ago, the correlation (price synchronicity) between the different asset classes has increased. Before the turn of the millennium, 16% of the price change of an equity in the US share index S&P 500 could be explained by the performance of other equities in the index. Today, this percentage is almost twice as high. According to a study by Ned Davis Research, which specializes in stock market analysis, the explanatory value over a range of investment categories (equities, commodities, interest rates, currencies) has increased 10-fold in the same period, from 1% to more than 10%. This greater correlation is likely to make the financial markets more prone to fluctuation and intensify investors’ search for alternatives.
as of 30.09.2016
as of 30.09.2016
|MSCI World Net USD
|Swiss Performance Index
|JPM GBI Global Traded TR USD
|Swiss Bond Index AAA-BBB TR
|Thomson Reuters/Jefferies CRB TR USD
|Real Estate Switzerland
|SXI Real Estate® TR CHF
|Exchange rate EUR/CHF
|Exchange rate USD/CHF
The increasing price volatility on the financial markets is well covered by our risk indicators. As a result of the constantly changing risk situation in recent months, our target portfolio has had to be changed at an above average rate.
Currently, we are holding an underweight position in real assets (equities, real estate, commodities), as the likelihood of corrections of the corresponding market indices remains high. The two prospective risk indicators that determine our target portfolio are currently moving in the opposite direction: The short to medium-term Turbulence Index (TI) indicates that the value of real assets could potentially increase before the end of the year. However, the unusually high Systemic Risk Index (SRI), which has a medium to-long-term orientation, and the fundamental valuation of the markets are sounding a note of caution.
Based on our long-term assessment, there are few arguments in favor of holding an overweight position in equities at present. Nevertheless, exaggerations can last a very long time and many investors are in search of alternatives. We therefore envisage the equity market experiencing a honeymoon period at the end of the year. In addition to the Tina principle and seasonal factors, this may also be due to the following:
- Swiss banks have lowered the recommended equity weighting for mixed portfolios five times in a row since the high in spring 2015. In the run-up to the US elections and the associated uncertainty, we expect the banks to reduce the target weighting again for the final quarter of 2016. The equity weighting will then remain slightly above the historical average, but for the first time since December 2013, the weighting would be expected to generate a positive return over the following 12 months.
- According to data from the Swiss National Bank (SNB), the proportion of equities held in custodian accounts at Swiss banks has also declined since summer 2015. We do not believe the weightings were actively reduced, but rather that a shift toward bonds and liquidity took place due to the better relative performance of bonds in comparison with equities. By the end of the year, some investors may find that their equity weighting – despite Tina – is suddenly too low, which could lead to corresponding top-up purchases.
- Fans of technical equity analysis point out that the global equity indices are in good shape. On both sides of the Atlantic and in the Far East, the indices are performing above their long-term moving average. From a technical point of view, this is a continuation of the rising trend since the start of the third quarter. In the traditionally weak final quarter, which runs from the start of July to the end September, all major markets generated a positive return.
Global financial markets – review
(See previous table)
The third quarter was all about the widespread recovery of the global equity markets. Equities in the Far East increased almost without exception, with Hong Kong (+12%) and Japan (+6%) leading the way. In Europe, the Brexit upheaval at the end of June was soon forgotten. With a rise of 9%, Germany’s benchmark DAX index was still above the UK’s FTSE 100, which climbed by 6%. With an increase of 3%, the Swiss Performance Index (SPI) closed slightly behind the index for the overall region (MSCI Europe, +4%). The US S&P 500 was able to escape the seasonal turbulence in the notorious month of September. After an increase of more than 3% by the end of the quarter, it almost hit the historical high of 2190 points, reached on August 15. The emerging markets did not hesitate either, with the MSCI Emerging Markets Index rising by a dollar-denominated 9%.
The Bank of Japan is doing everything it can to increase the money supply in order to stimulate the economy and fuel inflation. It announced its latest measure towards the end of the previous quarter – to influence interest rates through manipulation of the yield curve. However, for some time now all expansive measures taken by the central banks have failed. It is therefore not surprising that the bond indices in most regions barely moved in the third quarter. Interest rates have remained low over the last 12 months, and both franc-denominated (+4%) and dollar-denominated, globally invested indexes (+9%) have generated considerable returns.
The recovery of commodity prices that began in February came to a standstill in the third quarter, due in most part to the consolidation of oil prices. The price of the European oil type Brent was down 3% against the closing price at the end of June. Positive anomalies came from very different sectors. The price of the precious metal palladium rose by 20%, while the Baltic Dry Index (the price index for global dry-bulk shipping) skyrocketed by 33%. Baltic Dry is an early indicator of global trade.
With an increase of 5%, real estate in the UK cushioned some of the loss from the previous quarter. However, real estate prices are still about 10% below the previous year’s level. US real estate showed its resilience and despite the slight decline since the end of June managed to deliver a high annual gain of 20%. Swiss real estate funds chose the middle way: 1% increase over three months and 10% return over the past four quarters.
In the UK, the Brexit decision in the third quarter had a negative impact on the currency. Whereas equities and real estate gained ground between July and September, sterling was down by a considerable 4% against the Swiss franc. The continued resurgence of the yen was not intentional, at least not from Japan’s point of view. Despite the introduction of penalty interest, it rose by 2% against the franc rose in the third quarter. The most important trio for Swiss investors (euro, dollar, franc) drew the curtains on a turbulent 12-month period. However, on a year-to-year basis, the values of the different currency pairs were relatively unchanged at the end of September.