Continuing confusion in markets caused by political and central bank interference plagues hedge funds

The first half of 2013 will continue to cause problems for traders trying to read signals in markets pushed by political and central bank dictates. But various stimulus measures may pay off this year.

What song best describes markets for the first half of 2013?

Hans-Olov Bornemann, SEB
Like other trend-followers, we suffered from the “Hot-n-Cold” markets in 2012. However, in the last one to two months, the sun has been shining and our fund has been “Surfin’ USA”. In fact, our quantitative model is “Sailing” successfully with long positions in equities, bonds, short rates as well as riskier currencies. We are only steering clear of commodities where we continue to see “Smoke on the Water”.

While that is how our quantitative model forecasts the future, it is amazing to hear central bankers tell investors “Don’t You Worry Child” when they are pushing them into all sorts of junk at “Highway to Hell” prices. In a similar “Fashion”, an “Amazing” number of politicians are trying to lure the crowds “One More Time” with “Don’t Worry, Be Happy”, suggesting they should miraculously get rid of their loans by consuming even more.

However, having borrowed and spent so much “Money, Money, Money” for three decades now, people are getting seriously worried about the “Price Tag” for the “Party” that has been going “On And On And On”.

Will Europe be going for “The Final Countdown” in 2013? Will equity performance be “Big in Japan” this year? Will a sustainable recovery be “Born in the USA”? Will rates come down in “Africa”?

“Nobody Knows”, but if trends “Come Together” and CTAs have a good “Run”, the ones who have a “Ticket To Ride” would surely “Twist and Shout” “Yeah! Yeah! Yeah!” while the ones who “Let It Be” instead might be screaming “Help!”

Robert Sanborn, Sanborn Kilcollin Partners
As I think about a song that best describes how I feel the markets will behave over the next six months, “Walking on Sunshine” by Katrina and the Waves quickly comes to mind. Our current environment is one of continued excitement by market participants over government support, leading to feelings of euphoria and unrelenting optimism. Indeed, we are constantly bombarded with statements regarding how ‘undervalued’ stocks are compared with historical valuations and how ‘right now’ is the perfect time to invest.

Some of the opening lyrics of this song read:

“And I just can’t wait till the day when you knock on my door
Now every time I go for the mailbox, gotta hold myself down
Cos I just wait till you write me you’re coming around”

This is a great description of how market participants eagerly await the next government announcement on measures they will take to ensure that things won’t get any worse.

Unfortunately, as with the game of musical chairs, at some point in time the music stops and there are no more chairs left to sit down on. While the ending to this party might not happen during the next six months, it will happen, and our fragile economy will take a turn for the worse.

In the meantime, we can all remain blindly euphoric and continue “Walking on Sunshine” as long as possible.

Steven Bulko, Lombard Odier Investment Managers
As we enter 2013, we have serious near-term concerns regarding the lack of cohesive fiscal policies coming out of Washington, DC and the European Union, and the recent pattern of kicking the fiscal can down the road.

Our outlook, however, is constructive. In fact we believe that improvement in US housing and the unemployment rate are sustainable and that a pause in the European debt crisis will provide the time necessary for countries to continue much needed structural reforms.

With US consumer and corporate balance sheets the strongest they have been in years, we see the US breaking out of its anaemic growth pattern later this year, setting up 2013 as the year where investors return to risk assets and equities in particular.

While it is likely earnings growth will be tepid this year, rotation out of lower-yielding fixed income investments should expand equity multiples, which will provide the bulk of returns this year.

From a sector perspective, we remain focused on cyclical stocks over defensive names.

An interesting backdrop to all this is the extremely accommodative policies of the Fed and global central banks, which will serve to continue to stimulate growth and mitigate the impact of political indecision and confrontation. Their role in providing the liquidity necessary to do what fiscal policy-makers cannot do brings to mind the James Morrison song, “Fix the World Up For You”.
“Yeah, you’ll always know you’ve got someone
To fix the world up for you
When the world comes crashing down
I’ll be there, yes you know I will”

Angus Donaldson, Clareville Capital
Our core view is that the bond rally is over and that 2013 should mark a rotation into equities, so for bonds “Feels Like We Only Go Backwards” by Tame Impala may be appropriate but if, as an equity fund, we are to focus on the positive I would go with “Beginning to See the Light” by The Velvet Underground.

Over the past eight years equities have become increasingly unpopular as an asset class. This is set to change.

Back in 2005 few allocators could see beyond equities. However, that has reversed steadily since then.

Over the past five years $1.1 trillion has gone into bond mutual funds compared with $33 billion into equity funds. Given the long-term inflationary nature of the intervention in capital markets, we can see far more value in shares with secure growing yields than in government bonds with negative real yields.

Corporates on both sides of the Atlantic now have extremely strong balance sheets. They have been conserving cash and 2013 may be the year they start putting it to work. We expect some major bid activity this year. It is very interesting to see corporates tapping the bond markets at very favourable rates.

Indeed one of the most interesting events in the final quarter of 2012 was Amazon raising $3 billion at an average coupon of 1.6% with average duration of six years.

It is usual to add some caveats and caution. Europe may still have the occasional wobble. The cross-party discord and brinksmanship in the US will continue. However, the inescapable fact is, at a time when equities are underrepresented in many portfolios, the economic environment is improving and equity valuations do not reflect that.

George Papamarkakis, North Asset Management
“(I Can’t Get No) Satisfaction”. During 2012 European policy-makers and in particular the ECB were successful in averting a full-blown eurozone breakdown and, with the exception of Greece, ensured that peripheral sovereigns remained solvent. They also managed to significantly reduce financing strains in the wholesale bank funding market.

However, European policy-makers (and also those in the US and UK) did not manage to achieve the ultimate objective – a sustained recovery, growth and a concomitant improvement in the labour market.

As long as growth remains subdued with several of the eurozone peripheral countries in a recession, it is clear that policy-makers are not going to get the satisfaction they would have hoped for from their policy measures.

In fact despite the progress, the same serious risks remain in regards to growth and the longer-term solvency in the periphery. The eurozone’s underlying structural problems – competitiveness differentials between the periphery and the core, poor fiscal positions, large external debt loads in the periphery and weak bank balance sheets across the whole of the eurozone – remain large and for the most part unaddressed.

In 2013 we do not expect any substantial breakthroughs in terms of a fiscal union (burden sharing) and feel that policy-makers will only adopt such measures if markets test their resolve.

Meanwhile, the combination of economic weakness and fiscal austerity in the periphery will continue to be politically divisive and will most probably result in more openly euro-sceptical governments, further undermining the commitment of the existing governments to pursue more reform.

Political milestones such as the Italian and German elections will be potential market movers while in the US the risks associated with the debt ceiling negotiations seem to have been discounted significantly.

Finally, the first half of 2013 should be particularly interesting for Japan, which has now moved to the forefront of monetary policy experimentation (ahead of the US Federal Reserve, the Bank of England and the European Central Bank) by seeking to aggressively reflate its economy while simultaneously embarking on another round of fiscal stimulus.

Bearing this in mind, investors should be braced for volatility, especially considering the recent run-up in risky assets.