Evercore Pan Asset

The “logic” of the markets over the last four weeks has been curious. Investors have at long last been selling government bonds, realising that long term interest rates are low and may have to go up. Not liking the poor returns on cash, they have rushed into risk assets, buying shares in emerging markets and advanced markets in the first flush of love for risk.  What has changed that suddenly makes risk assets so attractive?

As you peer into the foggy future you do not see great conditions for any of the major economies. It is true that China and India are still growing rapidly, but both have serious inflationary problems, and both are taking monetary action to try to rein it in. If they are successful next year will see slower growth without a downturn. If they judge it well we could be into mildly stimulatory measures again before 2011 is out. If they get it wrong we could be in for more negative actions than we want, or a sharper slowdown when it finally comes. We think that is in the price of Chinese shares, where markets have been slow this year, but probably not in the price of India where the market has performed strongly.

The US is embarking on another round of quantitative easing. That is designed to make investors want to buy riskier investments, but it is a counsel of despair. The banks and the property sector remain impaired by the Credit Crunch. The political establishment is unable to agree about measures to start to bring the huge deficit under control. Next year should see another year of average growth, but even the USA has at some point to obey some of the rules of spending, taxing and borrowing. The tax break extension and this round of QE may well be the gambler’s last flings.

In Euroland the problems are acute and still unresolved. Some countries like Ireland and Spain have banking sector problems that are still to be sorted out. Some have large government deficit problems like Greece and Portugal. Many of the Euroland countries are struggling to grow at all, finding the mixture of the current level of the Euro, the restrictive policies on spending and taxing, and the regulatory culture all conspire to stifle entrepreneurial growth on the scale needed to get them out of debt and difficulty.

So what should an investor do? We think we saw the best of the gains in developed markets in 2009, and have seen very good performance in both 2009 and 2010 from most of the emerging markets. Bonds have done well since the bottom of the market, but are starting to deteriorate. Whilst corporate bonds retain a good yield premium over government bonds, and whilst the high grade corporates have good balance sheets on the whole in contrast to some governments, we have reduced our positions recently as longer term rates start to rise generally. We recommend a bit more cash in portfolios. We still prefer emerging market equity to advanced equitty, but by a smaller margin and with more discretion, as we think some of the markets are now  reflecting the superior growth in their prices.

A very happy Christmas to all our clients and readers.