Half Time Report
David Miller - 12.8.08
Now that the UK banks results season is over there is a distinct end of term feeling as investors close their books after an eventful first seven months and start their summer holidays.
In his book the (mis)Behaviour of Markets, Benoit Mandelbrot, the inventor of fractal geometry, makes the point that market time, unlike normal time, is relative. Large gains and losses are concentrated into small packages of time with long periods where relatively little happens. For example, between 1986 and 2003 when the Yen doubled against the US dollar, 50% of this change happened in only ten trading days out of a total of 4,695. This year we have experienced intense volatility in all asset classes, somewhat understated by the indices.
Performance
Half Time Report
Source: Bloomberg
In trying to judge where financial markets might take us from here, it may be worth revisiting some of the themes covered in my previous notes.
In January the topic was turbulence and the activities of major investors such as the Asian central banks and sovereign wealth funds. After a period in which they bought ‘cheap’ bank stock at significantly higher prices than now, new capital has been less forthcoming. What is clear is that investors with capital are able to set prices, whilst those who need to borrow have been marginalised.
The Federal Reserve and the European Central Bank have followed their anticipated, but different paths as they try to solve the “credit crunch” with the Fed cutting interest rates and ECB holding firm, but instead pumping liquidity into the financial system at an exceptional rate.
The February note dealt with financial models and in particular the comfort blanket provided by spurious accuracy. Although market traders would express themselves rather differently than Professor Mandelbrot, they would intuitively agree that markets move very differently to the models used by banks and investors to control risk. Trouble runs in streaks and uncorrelated assets correlate in times of stress. That is the lesson of the last twelve months. Active investment based on sensible judgements using available, if sometimes incomplete, information has been critical to success. Passive investors with long term strategic plans are struggling because markets are just more risky than standard efficient market theories suggest. As predicted, volatility which went up last year has stayed high. Investment strategies that benefit from volatility have done well so far this year and are likely to continue to add value throughout the remainder of 2008 and 2009.
Download August's Monthly Note in PDF file format