Investor nerves seem most apparent in the volatility of oil prices, where, at the beginning of June, the price of Brent crude oil traded at just over $115 a barrel – a nine month high.
Performance of index over 1yr
Source: FE Analytics
Analysts point out that price is dangerously close to the $120 a barrel barrier – a level at which, based on historic trends, the global economy slows.
Yet despite renewed worries of a potential slowdown in growth, the US stock market continues to flirt with all-time highs. So, could it be that while the US celebrates political independence, it has shaken off its dependency on oil too?
While it may seem hard to imagine, statistics from the International Energy Agency show that the US is set to overtake Saudi Arabia as the largest producer of energy. Thanks to the large deposits of shale gas and oil coming on stream, US crude production rose to its highest level in twenty five years in 2013.
As long as it remains illegal for the US to export crude oil (with a few exceptions), inventories will remain high, resulting in chemical, manufacturing and other oil-intensive users benefiting from a ready supply of cheap energy. In Smithsonian terms, the US currently enjoys a huge competitive advantage.
Geopolitical tensions come at a time when investors’ nerves are already frayed. While, on the surface, the market mood appears calm, particularly when measured in terms of volatility, underneath there are multiple undercurrents which can be inherently unstable.
Performance of indices over 3yrs
Source: FE Analytics
At the end of 2013 many portfolios were positioned for a pick-up in economic growth. That’s to say that investors tended to overweight cyclicals and shied away from expensive, defensive stocks.
In bond markets, the beginnings of US Federal Reserve tapering meant, in theory, that bond yields would actually rise.
As systematic equity investors, instead of forecasting significant macro developments, we are much more interested in how investors, as a whole, react to highly unpredictable macro events. In so doing we are effectively taking the ‘temperature’ of the market and use that as our starting point for stock selection.
Once we have established the right market environment we can then ascertain which stocks perform in that particular type of climate.
In building the portfolio of stocks from the ‘bottom up’ rather than the ‘top down’ our emphasis is on obtaining returns from diversified alpha sources.
Unlike many fund managers we prefer not to make the distinction between cyclicals and defensives. Instead, the model gleans, from its key indicators, where certain stocks sit in a particular environment.
Are they quality or value stocks? Are stocks displaying short-term, one-off growth characteristics, or sustainable growth characteristics? The end result is that the process is a dynamic and flexible one.
By definition because the process is continuous, all emotion is taken out of it. This can be hugely beneficial, and a viable alternative, to those managers who pride themselves on a particular style and stick religiously to it.
US politicians are often accused of pandering to voters, of changing their opinions to fit the current political climate, a process commonly known as flip-flopping. While the term carries a negative connotation, it can equally be a positive characteristic.
By having a dynamic, flexible investment style, devoid of emotion and sentiment, a significant change of market environment will result in the portfolio changing to reflect that.
As fund managers it is important that we change our minds when the time is right – the difference is that we do so in a rational and informed way, irrespective of where we think the oil price will be or what will happen to US interest rates.
Ian Heslop (pictured on page one) is head of global equities at Old Mutual, and lead manager of a number of portfolios including the five-crown rated Global Equity fund.
