An independent professional's take on the latest news and trends in global financial markets

Time to watch that basket closely

An interesting range of views from market-watchers in this story from the Financial Times today.  Investors are slowly waking up to the lopsided nature of the currrent global market dynamics, in which there is an apparently real risk of a severe negative market event – either in Europe or in the United States – but one which still falls short of being a likely outcome.

How to position yourself  if you rate the probability of this occurring at say 20%? Is that high enough to justify taking extreme defensive action in anticipation of just such an outcome? That will ultimately depend on your tolerance for risk. A number of well regarded fund managers whose opinions I track have taken their holdings of cash to higher than normal levels in recenet weeks, although few have taken it as far as George Soros, whose Quantum Endowment Fund,  as I noted yesterday, is reported to be 75% in cash (although this is likely to include a range of currencies, which these days are often treated as proxies for other types of investment).

Here is an extract from the FT story:

The belief among some leading investors – all of whom have long been optimistic about stocks – is that stock markets are more likely to exit the narrow range of this year by falling than by rising. “The opportunity to the upside is very limited and the risks to the downside of a couple of black swan events are increasing,” says Andreas Utermann, chief investment officer of RCM, the equity fund manager owned by Germany’s Allianz.  The worry is that one of the twin debt crises in the US or the eurozone could dramatically worsen in the coming weeks, causing a crash in both markets and economies.

Dan Morris, a market strategist at JP Morgan Asset Management, estimates there is a 20 per cent chance “of it ending badly – a catastrophic outcome”. He adds, with some understatement: “It is an interesting market to invest in.” Others see similar probabilities of big trouble ahead.

Ben Funnell, a fund manager and chief equity strategist at Man GLG, the UK-based hedge fund, believes there is a 70 per cent chance equities will remain range-bound; a 20 per cent chance of a liquidity crisis that could see shares halve; and only a 10 per cent probability that earnings could surprise positively and markets rally. “The downside scenario is quite plausible and really big. The upside scenario is less plausible and less big,” he says.

The chart of the UK market meanwhile is also entering a crucial stage, with the 50-day moving average having moved below the 200-day moving average for the first time since September last year. If this is followed by the 200-day moving average itself turning down (which failed to happen during the first Greek crisis last summer), that will be a classic warning sign that the bull market which began in March 2009 may finally be about to roll over.

It is not a certainty – there are no such things in markets – but these simple broad technical dynamics are one of a number of telltale indicators which normally give reliable signals about market direction. Another way of saying something similar is that ranging markets – those which track sideways without much direction – tend to make decisive moves one way or another when they finally break out of those ranges.

The stakes, in other words, really are becoming pretty high for the US debt ceiling talks, to take just the latest potentially game-changing market risk.

Written by Jonathan Davis

July 29, 2011 at 6:08 PM