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Insight - Making Sense of the Narrative


Periodically, we take the opportunity to refresh our portfolio of Themes, incorporating new ideas to replace ones that that we think are no longing offering attractive risk return opportunities. We monitor the new ideas for a period, before incorporating them when we think the risk return is attractive, guided by our confidence scoring systems. As the risk return profile more generally has improved and as we reallocate cash back into our themes, we have added two new themes from our 'watch list' - Japanese Wholesale and Trading Companies and Emerging Markets ex China. The note provides more details and background.

Recency bias might lead us to think that the weakness in October was all about Gaza, but there were clear signs of fragility already appearing in bond markets as the mark to market impacts of the bond bear market continue to lead to forced selling, particularly in Japan. The key to stability is for cash to move out along the bond curve in fixed income even though we would not expect cash rates to fall much. however, the narrative will likely turn to slowdown to support the bond narrative, and we suspect the cash pile destined for equities will go to high quality dividend yield stocks offering the prospect of quality compound real returns. We thus expect a flip in Asset Allocation - from Long Duration Equities and short duration bonds, to Long Duration Bonds and Short duration equities

Watching flows helps us to look for influences other than fundamentals. We are watching Money Market inflows show a sign of slowing and reversing, the trader flows into the Magnificent seven (the only part of the market with inflows) doing something similar - also demonstrated in the long NASDAQ short S&P 500 flow and the trade to switch from EM to EM excluding China also appears to have stabilised. The first stop for those money market funds we suspect will be longer dated bonds, while the second will be shorter duration equities with strong cash flows and higher yields. While the world sits in cash it is worth doing some research as to where to go, when, not if, they start to deploy. Here too, flows can help us with our searching.

Our own experience confirms that most of the problems facing active fund managers are structural to the industry, ironically largely a result of risk management processes that limit the ability to vary benchmark risk according to market conditions. The model portfolios we discuss here on Market Thinking have been built over the last three years to explicitly avoid these issues and look to take the appropriate level of risk in both high conviction and low conviction markets - our definition of conviction being the scores we create as part of our market thinking process at the portfolio component level. As more than 2/3rds of the time we are in such markets, we see this as a key part of generating long term returns while having lower volatility and downside risk.

This is a video I recorded with Neil Shah at Vantage around three weeks ago when I was passing through London. Similar to the CISI subject but with more detail on the work we are doing with Toscafund.