Asset Allocation Shifts May Explain ‘Disparities’ Between Equity Markets and Economic Reality

Terry Flanagan

Huge asset allocation shifts by institutional investors back into equities—and not a prolonged and sustained global economy recovery—could be the underlying reason for the sparkling start to the year witnessed by equity markets.

With concerns about the U.S. fiscal cliff and the eurozone crisis abating for now, global equities recorded strong gains for the month of January as investors piled back into the market. But this turbo-charged start to the trading year is troubling some asset managers, with warnings that the recovery may have been built on sand.

Ricardo Arroja, chief investment officer, Pedro Arroja

Ricardo Arroja, chief investment officer, Pedro Arroja

“There is a huge disparity at the moment between the financial markets and on the ground,” said Ricardo Arroja, chief investment officer of Pedro Arroja, a Portuguese investment manager based in Porto and author of a recently released book on the Portuguese economy.

“In Europe, for instance, unemployment is still high, especially youth unemployment rates in southern Europe. Things are also slowing in China and weaker growth figures have been coming out of the U.S. in recent days. There are also a lot of monetary gimmicks that are distorting things.”

There is no doubting that the picture appears slightly rosier than a few months back—with some signs of economic stabilization in the U.S. and Europe and market armageddon events seemingly sailing out of view—and it may be that this combination is proving the catalyst for institutional investors to head back into equities in a big way.

“Sentiment has improved in part because several uncertainties have been removed from the market,” said Frank Holmes, chief executive and chief investment officer of U.S. Global Investors, a San Antonio-based investment advisory firm.

Safe-haven assets, such as cash and fixed income, which have been mainstays for many since the financial crisis broke, are now beginning to look less attractive as riskier plays come back into view.

And it seems that institutional investors are beginning to realign their portfolios in various asset classes to more traditional levels and this rotation alone could conceivably continue to prop up equity markets for some time to come, even if global economic data going forward disappoints.

“Most investors have been over-allocated to cash and to fixed income assets for years, and their under exposure to equities has reached record levels,” said Swiss-based hedge fund shop Gougenheim Investments in a recent note covering it Glasnost Fund, a global macro hedge fund.

“For example, U.K. pension funds, which had an allocation to equity above 70% and up to 80% in the 1990s, and above 60% in the 2000s until the crisis, have now less than 40% invested in equity.

“Many insurance companies in Europe currently hold less than 10%, and sometimes even 0% of their portfolios in equity. Recent market moves, triggered by more competitive monetary stimulus from central banks and by some better economic figures, have supported a stronger risk appetite from investors.”

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