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Archive for the ‘Dahval Joshi’ Category

Unusual correlations

I am grateful to Dhaval Joshi of RAB Capital for the observation that something unusual happened in the month of September – bonds, equities and gold all went up together. This is not something that is meant to happen, and rarely does. In fact, according to RAB Capital, the last time this happened was in the early 1980s.

He comments:

Such a conjunction of asset returns is a rare event in the financial markets. In the 123 calendar quarters since 1980, there have been just 4 other quarters, each in the 1980s, when all three asset classes have gone up by 4% or more. The rarity of this event is because there are virtually no economic or financial scenarios that favour equities, government bonds and gold at the same time – at least under normal circumstances.

The obvious reason for this anomalous turn of events lies in the prospect of further quantitative easing by central banks in the US and UK, allied to monetary stimulus elsewhere – which together are creating massive distortions in asset prices. These are not normal markets and as always when asset prices move in mysterious ways, plausible rationalisations are always at hand. The trick is not to be conned into believing that a distorted market can endure indefinitely.

On the previous occasions that equities, bonds and gold moved up together, at least one of the assets ultimately proved to be mispriced. At the end of 1980, bond prices declined by 20%, while gold plummeted by 40%. In 1983, bond prices fell 10%. And in the middle of 1986, bond prices again dropped by almost 10%. This time too, the assumptions underlying the simultaneous rallies may eventually turn out to be inconsistent with each other.

Note that for equities, both deflation and rising inflation are ultimately enemies. Deflation is a threat to the nominal value of profits, while rising inflation normally means a declining profit share of income. Hence, a portfolio of long dated deep out-of-the money put options on equities, bonds and gold could produce handsome returns. One, or even two, of the options could expire worthless. But for the asset that breaks down, the value of its put option could multiply several times over.

Well, the idea is smart enough. To judge the value of the put option strategy depends on how the relevant options are priced. It is simpler to take a view about which asset class is wrongly priced. Short term, both gold and equities look overbought, so corrections are likely after their strong recent momentum moves. Bonds are the obvious midterm casualty, as they were on the previous occasions.

Written by Jonathan Davis

October 13, 2010 at 1:14 AM

Sterling and Equities

By opting out of the euro the UK has saved itself the travails of a Greece or a Spain, which looks like being next in line to feel the full force of the markets’ assault on over-indebted countries. Yet as Dahval Joshi of RAB Capital points out in his latest market commentary, by taking the strain through its currency the UK’s investors are not immune from important shifts in global investors’ attitudes.

This chart from Dahval’s report shows the close correlation between the movement of the London equity market and the value of sterling against the dollar. For the last five years it has been a more or less perfect fit, even though there has been a slight deviation from trend in the last few weeks.


The globalisation of financial markets has of course been a big factor behind the growing dependence on foreign investors’ views. Twenty years ago, foreign ownership accounted for little more than 10% of either the US or the UK stock market. Today the foreign holding of the US equity market has doubled to 25%, while foreign ownership of the UK equity market has actually quadrupled  to 46%. Big moves into or out of equities have necessarily meant foreigners buying or selling large quantities of pounds.

“Another way to explain the impact of equity flows on sterling” Dahval notes “is to look at the equity market capitalisation to GDP ratio of the UK compared to other major economies. The market capitalisation measures the total value of the equity market, but the amount of domestic savings that are available for investment tends to grow in proportion with GDP. So the greater the market cap to GDP ratio, the greater the dependence on foreign investors. And the UK’s ratio, currently 1.2, has been structurally much higher than other major economies such as the US (0.85), Japan (0.65), Eurozone (0.45), or China (0.4). This explains why the pound is highly vulnerable whenever the equity market sells off”.

Just as pertinent is the fact that more than 50% of UK corporate and Government bonds are now owned outside the UK, roughly twice the ratio that holds in the United States, which means that sterling could be additionally vulnerable if the UK’s perceived debt dependence prompts an adverse reaction in the markets. Devaluation has always been the UK’s stock policy reaction to economic difficulties, but investors are increasingly dependent on foreign investor sentiment. Being out of the euro is a blessing, but that does not remove the need for tough measures to correct the looming fiscal crisis in this country.

Written by Jonathan Davis

February 23, 2010 at 1:09 PM