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This week I went to Monte Carlo. I was there for an investment conference and in the evening I found my way to the Casino. I rarely gamble but the temptation was just too great.
I spent some time on the roulette table and was intrigued by the number of people who simply do not understand maths or probabilities. Most punters would monitor the historical pattern of winning numbers to try and improve their chances of picking the next one. If the previous number were a 6, practically nobody would put their money on this number again. If black came up, people would automatically assume there was a higher probability of red next time. Of course each event is independent and the past has no influence on the future. People continuously looked for patterns that were simply not there.
Many investors fail to avoid some of the biases of the gamblers. Many technical analysts look at historical returns and graphs to try and discover hidden patterns and then use these to predict what will happen in the future. Good luck. Others look at the past performance of fund managers to predict future returns. While this makes a little more sense than the close monitoring of the numbers on a roulette table, the odds of success are against you.
Markets & Economy
I do believe, as investors, we have a greater chance of making money in the markets than on a roulette table but we need to be aware of some of our biases. We should not be fooled by nonexistent patterns in historical data and we should be aware that most of the information and news is simply noise.
There are always risks when one invests. In fact now the list appears longer than usual but these risks must be weighed against valuations. On this front, European equities appear interesting. There is a long list of European companies where the dividend yield is higher than the yield on the corporate bonds. This doesn’t really make sense and would at the very least suggest that corporate bonds are overvalued.
Furthermore the PE on a forward basis is close to just 10. I do believe that if you take out the political risk/government default risk/EUR risk, European equities could surprise. Everyone is looking at the downside not the upside potential in this market. The cost of put options is near a 10 year high, which would suggest over caution. All investors and fund managers I meet claim to be contrarian. Right now one of the biggest contrarian investments would be to invest in a European equity fund.
However we all appear obsessed with emerging markets. I do not deny that emerging markets will continue to see growth. Their GDP will, most probably, over time continue to grow. You should be aware, however, that there is no correlation between GDP growth and equity market returns. It reminds me a little of 1999. Those investors who predicted the technology revolution, including the development of mobile Internet online shopping and smart phones. They were correct as 10 years later, all these things do exist but investors in technology funds in 1999 did not make any money.
The EUR continues to attract attention and everyone now has an opinion on its future. The reality is that nobody really knows what will happen. The key is to protect your assets from a number of different scenarios. There has never been a successful monetary union without political union. Over time, Europe will have to unite politically or the longer-term future of the currency will be put into question. In this case you will want to own equities rather than bonds.
I have been positive on Sterling compared to the EUR ever since it approached parity and I continue to believe that GBP will continue to appreciate certainly against the EUR and possibly even against USD.
As a final point, US politicians should remember that a floating currency can also fall and is not guaranteed to rise. They should remember this when China decides to float its currency.
Risks are everywhere, and the one that causes the biggest disruption may well be one that we have not yet identified. I would argue that the time to really be worried is when everyone is relaxed. This is clearly not the case now. We are continuing to invest for clients and believe that equities, in developed markets are looking attractive. We are reducing our exposure to investment grade corporate bonds for reasons already explained. It is still important to balance equities with some bonds and some diversified hedge funds. The key is to be flexible, and ensure your portfolio is liquid so you can change your positions if you change your mind.
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