(1) Short term squabbling between global politicians of all different stripes as they jostle for short-term advantage, whilst their electorates are ever more disconnected from what is increasingly seen as a self-serving political process,
(2) A "recovery" that has been seen to benefit a limited few at the expense of the many
(3) A lack of willingness to address longer-term structural issues which simply increases the longer term costs of addressing such issues
(4) A host of geo-political brushfires which, taken separately, have a negligible global impact, but when taken together point towards a shortage of the leadership momentum that has been so important in keeping such issues under control since the end of WW2.
If you take all these issues together, you have a situation in which the "system" is creaking under the the cumulative weight of dissatisfaction and the possibility of a self-inflicted, knee jerk short term shock rises significantly. Grumpy or stressed investors will react more emotionally than they otherwise would. Bear in mind also that leverage within markets is fairly high - the Asian fixed income market is heavily supported by investors who have relied on cheap debt as a means of plying interest rate arbitrage - and therefore potential margin selling on any correction will magnify selling volumes. Remember too that, unlike the early part of 2008, the ability of banks to provide market making capacity in the fixed income market is now much more heavily constrained by capital a regulatory restrictions.
Our stance on stockmarkets has been that these continue to be the default investment option if only because the alternatives: cash, bonds, commodities etc., look much less palatable. However, we also know that when markets have risen for a long time, nervousness around the central theme of "how much further can they go?" increases, regardless of whether or not they continue to provide reasonable investment value.
We seem to be edging closer to the point at which markets could indulge in a period of self-inflicted blood letting, which is likely to be short but sharp as we have seen on previous occasions in 2011 and 2013. The catalyst seems likely to be political: the US mid-terms at the beginning of November will end an uneasy short-term truce between Republicans and Democrats, and if the former take control of the Senate, their objective will be to reopen old wounds over the debt ceiling and the budget. Remember the "fiscal cliff"?
In the background will be political rumblings in Europe and the UK, which will once again call into question the integrity of the EU and the Euro.
When that happens, Asian and Emerging Markets will get hit hardest (because they always do), since the combination of falling markets and falling currencies will mean bigger declines for foreign investors, and therefore faster moves for the exit as a way of preserving capital. Obviously such moves are self-defeating unless you are one of the fortunate few to have moved early.
The point here is that overall risks are rising, even if the alternative to investing in stockmarkets is non-existent on anything other than a very short-term view (which would favour cash, and specifically USD's). It's obviously going to be impossible to predict the exact timing, so perhaps investors should start adjusting their risk/reward expectations over the next six months: accepting the lower returns that come from holding more cash or very conservative fixed income products, in the interest of preserving longer-term value.
To say that this will be a tricky act to pull off is an understatement, but the downside risks are certainly larger than they have been for a very long time, and prudence suggests that a gradual increase in cash weightings over the next few months would be sensible.
Does this now mean that we think the "perma bears" now have a point - after at least 3 years of howling in the wilderness during which stock markets have risen by a third or more? Even a broken clock is right twice a day...
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