Tuesday, August 17 2010
There was a very interesting article in The Australian today in the business section talking about the correlation between Oil markets and Equities. I think you could also add Currency and other commodities as well and possibly bonds.
There seems to be a lot of hedge fund money investing in global macro strategies. From what I understand this has traditionally been one of the more difficult areas to consistently make money. The investor needs to correctly predict the direction of economies and the impact this has on relevant markets. I believe the reason a lot of hedge funds are using this strategy is that a small number made an enormous amount of money using the strategy during the GFC. The more money that goes into the trade the less likely a return will be generated.
A number of people are looking at the direction of bond yields and comparing them to equity markets. The bond yields have recently diverged especially in the US since the Fed Reserve highlighted further quant easing. This has raised concerns that the bond market is predicting a sharper slowdown than equity markets. Do the credit markets know something equity markets do not? This is possible but it is also interesting that oil is still over US$70 a barrel, and the A$ is around 90c so not all markets are predicting the slowdown the credit market seems to be.
What is an alternative explanation? The Fed Reserve has highlighted that they will not be moving short term interest rates any time soon and they will also be supporting the long term bond markets.
So it seems pretty rational for hedge funds to gear in the short term and invest in longer term bonds. They might only make a small return but if you gear enough the trade should work. This is really the carry trade at work. Someone once described it as picking up pennies off a highway in the desert. It works a treat until a truck comes along. We also understand the bond funds continue to attract funds so that you are having money squeezed into bonds.
In our view equities look very good value relative to bonds. Why buy a bond yielding 2.5% for 10 years when you can buy a high quality blue chip like Procter and Gamble with a 3.5% yield that is growing.
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