Remain focused amidst the noise

The first weeks of 2012 have witnessed incredible strength across both equities and fixed income securities. The extent of this strength comes somewhat as a surprise to me as I wait for some kind of credible resolve on the European front. Furthermore, this resolve will require a substantially lengthy lead period for the resulting action to take place and even more time to gauge the results.

I strongly believe that we are not out of the woods yet and that all possible outcomes are still in play- Karl Micallef

Admittedly, there is reason for renewed confidence that the bigger macro economic picture could improve both in Europe and the US. However, in an extremely short period of time, markets seem to have either forgotten the dimension of the fundamental issues Europe is faced with or have decided to stick their heads in the sand and move on. Equity markets have frequently demonstrated an ability of doing the latter only to be slapped in the face with reality.

On the other hand, bond markets are usually superior indicators of reality and even on this front we have seen remarkable strength especially in financials. I understand that the three year loans provided to European banks (LTRO) at very favourable rates will ease the pressure which built up last year, but the rally in these banks’ debt instruments during the past six weeks seems to have tipped the risk-appetite-pendulum to the other extreme of the risk spectrum.

In the meantime Greece is in no better shape – on the contrary. In the recent past the possibility of Greece exiting the eurozone was only mentioned but never really considered. Today, there are plans being prepared to make this outcome a real possible option. Germany is clearly running out of patience with the Greeks and would like to have more control over the bailout funds forwarded to Greece.

The most recent update on this front is to establish an escrow account, which would accept part of the bailout funds, rather than having all the funds forwarded to Athens. This is being done to safeguard part of the funds required to pay off Greek debt holders upon maturity and hence indirectly apply more pressure on the Greek government to deliver results.

On the other side of the pond, the US is starting to show some signs of improvement. There is much less talk about a double dip recession and much more focus on not losing the momentum gained in the last quarter of 2011. We must also remember that 2012 is an election year in the US and therefore one can assume that all the economic levers will be set on maximum to maintain and further strengthen this recovery.

Amidst all this noise and various economic score cards, the markets have been very strong and I feel, as a portfolio manager that we are yet again at another crossroads. Should one take advantage of these markets and take a risk off approach given that the fundamental, structural problems are still very real or should one keep riding this wave? The difficulty in answering this question is the belief that the markets could still demonstrate an unexpected level of nervousness and turn around very quickly.

Applying trailing exit prices could also be a practical solution but this approach requires constant monitoring. Opting for the easiest way out (i.e. selling in this strength and applying more resilience in investment portfolios) may not always be an option if your performance is being benchmarked. Therefore, one must be bold and always look at the risk versus reward scenario – this approach has always worked favourably for us and our investors.

I strongly believe that we are not out of the woods yet and that all possible outcomes are still in play. Furthermore, I also believe that active management will outperform passive management over the next couple of years, as the swings of the risk-appetite-pendulum move from one extreme to another in very short time periods. Calling this juncture correctly is very important for this year’s performance, but admittedly it is a difficult call to make.

Remaining focused on fundamentals must remain the basis of any investment decision when addressing the core of a portfolio and one must resist the temptation of being less disciplined and moving with the flow.

Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Any opinions that may be expressed here above should not be interpreted as investment advice, nor should they be considered as an offer to sell or buy an investment. The company and/or the author may hold positions in any securities that might have been mentioned in this report. The value of investments may fall as well as rise and past performance is no guarantee of future performance.

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Mr Micallef is an executive director at Curmi and Partners Ltd.