Befriend the trend...

Posted On Monday, Sep 15, 2014


"There is nothing new under the sun”, said the wise man. It’s true; history repeats itself. Often people shape their expectations of future returns from the recent past. Currently the stock markets have got all the attention of investors as they are surging. This behaviour is described as trend following.

However most investors fail to view history in totality and instead focus only on the recent past, chasing recent good performances. Such trend investors consciously or subconsciously seem to believe in a saying- “The trend is your friend”. However, in the real world, this adage seems to be only the half truth. The phrase needs to be modified to “The trend is your friend, until the end when it bends.”

Sometimes the underlying structure of the world changes rapidly with disastrous consequences for trend-following investors. Especially markets plagued with intervention, like liquidity infused by central banks, are not supported by a fundamental foundation. When the artificial support goes off, it all comes down like a house of cards. . When you dig deeper into the underlying factors, it will be apparent that it’s a bubble waiting to burst.

Central banks seemingly changed the underlying structure of the world 2010-11 onwards with the magical wand that opened the taps of liquidity. The aghast / risk averse state of markets suddenly changed to a fearless, aggressive, risk loving state. There were a series of monetary infusions by central banks across the globe, and in addition interest rates in many countries spiraled down close to zero levels and this reignited the appetite for risk.


Table: Liquidity measure by major central banks since 2010


Period

Central Bank

Liquidity Measure

Amount

May-2010

ECB

Securities Market Programme (SMP)

€220 billion

Oct-2011

Bank of England 

 QE

£75 billion

Oct-2011

BOJ 

Asset purchase program

¥5 trillion

Nov-2011

ECB

Covered Bonds Purchase Programme (CBPP-2nd)

€16.4 billion (announced target was €40 billion )

Dec- 2011 / Feb- 2012

ECB

LTRO

€1 trillion

Feb-2012

Bank of England 

 QE

£50 billion

Jul-2012

Bank of England 

 QE

£50 billion

Sep-2012

ECB

Outright Monetary Transactions (OMT)

Nil -Announcement was enough to change market behavior

Sep- 2012 / Dec- 2012

U.S. Federal Reserve

QE3

$85 billion per month

Apr-2013

BOJ 

Asset purchase program

$1.4 trillion


Source: Bruegel, Federal Reserve, BOJ, Bank of England


If you notice, there were a series of quantitative measures aka money printing programs intiated by major central banks around 2011-12. The liquidty propelled a move towards risk and a search for yield. And this is exactly the time when gold topped and started correcting as a result of movement of money towards risk assets.

The comparison of asset markets and unprecendented advances seen in Fed balance sheet provides a strong evidence of the great rotation marking a move towards risk assets (represented by U.S equities).


Chart: Equities, Gold and the Fed balance sheet



Source: Bloomberg


Past Performance may or may not be sustained in the future

A closer look from 2012 onwards shows the lockstep movement in Fed balance sheet expansion and the surge in equity markets.


Chart: Equities, Gold and the Fed balance sheet


Source: Bloomberg


Past Performance may or may not be sustained in the future


Going forward:

Equities are likely to get corrected soon as they are getting increasingly expensive by the day. Asset markets which have risen on the back of liquidity infused by central banks will feel the impact of lower money on the table as the U.S. QE finally tapers and finishes likely by October, 2014. The markets have been reactive of geo political developments across the globe. Any flaring of these issues or any surprises from the upcoming U.S. by-elections in early November this year could potentially serve as the tipping points for any ensuing correction. Weaker prices in equity markets could trigger some renewed investor buying in gold.

Investors should avoid chasing markets just by looking at recent performance of a particular asset that is not backed by strong fundamentals and are rising just on the back of sentiment. Markets driven by artificial liquidity are nothing but frothy markets which will sooner or later turn to nasty corrections.

It will be advisable to remember the full quote “The trend is your friend, until the end when it bends.”


Data Source: Bloomberg, World Gold Council




Statutory Details and Risk Factors:
The views expressed here in this article are for general information and reading purpose only. The views expressed here do not constitute any guidelines or recommendation on any course of action to be followed by the reader. The views are based on the publicly available information, internally developed data and other sources believed to be reliable. The views are meant for general reading purpose only and are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the readers. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and opinions given fair and reasonable. Recipients of this information should rely on information/data arising out of their own investigations. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. None of The Sponsor, The Investment Manager, The Trustee, their respective directors, employees, affiliates or representatives shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this document. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.


Above article is authored by Quantum.

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