Tactical Asset Allocator: Is this a sign markets are about to topple?

Is this exchange traded fund (ETF) launch a sign that financial markets are ripe for a fall? 

A new exchange traded fund (BATS:CEFS), launched by Saba Capital, believes it can make money by putting pressure on investment trusts that are on heavy discounts to their NAVs to boost their performance.

There is probably a lot of merit in the idea. However, closed-ended funds are not some esoteric, illiquid asset class that requires proprietary research and development, yet the new ETF has an expense ratio of 2.42 per cent. Of this figure, 1.1 per cent is going to management fees and the other 1.32 per cent is from acquired fund fees and expenses, but still, can such layering of fees possibly be justified? Surely heavily structured launches such as this mark the top of an overvalued market? 

The ETF is run by Boaz Weinstein, who made his reputation on the other end of JPMorgan Chase’s $6.2 billion credit derivative trade debacle in 2012, which was pinned on trader Bruno Iksil but was probably part of a wider malaise at the bank. This is a very different skill set from executive management, and clearly much will have to go well before investors see a real return on their money, which leads to the question of whether investors should be buying at all now, at a time of such geopolitical turmoil and high stock valuations. 

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President Trump’s position already looks precarious. His travel ban barring refugees and citizens from certain Muslim-majority countries is tied up in the courts, while the cancellation of the vote on the new healthcare bill has led to an unedifying blame-game against his fellow Republicans. 

Many investors are hoping for small and measured falls in US equities in the coming weeks, on the assumption that this would preclude a large tumble. So far, so good. Even the US’s increasingly tense stand-off with North Korea, and further pressure on China to reign in its neighbour’s recent military activity, have so far been shrugged off by the markets. 

Something will push markets over the edge, however, and that could be the investigation into the presidential campaign’s links to Russia, and Michael Flynn, who resigned only 24 days after becoming national security adviser. Flynn, who has styled himself ‘General Misha’ (Russian for Mike), says he’ll cooperate with the FBI and Congress in exchange for immunity, which implies some kind of wrongdoing. 

Steps backwards for UK

In the UK, manufacturing took another step backwards in March, with PMI data showing growth in the sector had slowed for a third consecutive month. The boost of a weaker pound appears to be on the wane, and PMI readings will become increasingly critical in coming months, as the post-Article 50 environment takes shape and the snap general election called for 8 June approaches. 

At the moment, UK investors are still buying on dips, and there is an enormous weight of cash on the sidelines ready to jump on every possible opportunity, which should ward off a sharp fall – certainly the 40 per cent some pundits have predicted. A meltdown seems unlikely in the remainder of April – traditionally one of the strongest months in the markets’ calendar (see the Almanac on page 13 of the April issue) – but the summer months will drift sideways at best. 

Our portfolio is already relatively underweight the US and UK, but for anyone who has stayed close to world benchmarks, with 40 per cent in the US for example, the risk is all on the downside. 

Against this backdrop, Europe and emerging markets offer opportunities, even at current levels, with a better outlook than for a while. With the French election looming in late April/early May, German elections in September, continued uncertainty in Italy, and the $6 billion (£4.8 billion) in Greek bonds due in July, confidence is low in Europe, but the region could benefit greatly from global reflation. Eurozone PMIs have shot up to their highest levels since 2011. Inflation is likely to remain moderate for some time and monetary policy should be accommodative, despite rising rates in the US. 

If Emmanuel Macron succeeds in France, and Angela Merkel sees off Martin Schultz, a centre-left, pro-European majority will hold the heart of Europe, cementing the relationship between France and Germany. It’s far from an odds-on outcome, but if this scenario should come together it could lift European markets for years to come. 

The outlook for emerging markets has also improved as Trump has taken a more relaxed view on protectionist policies in power. Market concern about the pace of interest rate rises from the Federal Reserve and its impact on emerging market capital flows, which was such a worry just a few weeks ago, has all but vanished from discussions. 

Souring on Saudi 

In particular, emerging market bonds are likely to be less sensitive to higher rates in developed markets, given the massive gap in real rates and fading concerns about trade, the Fed, commodity prices and foreign currency reserves in China. Our portfolio holds 300 shares in iShares MSCI Saudi Arabia Capped ETF worth around £6,000, which have increased by over 20 per cent since we bought them in May last year. Concerns about rising debt and falling reserves have prompted Fitch Ratings to lower its assessment of Saudi Arabia’s credit quality by one notch, to A+. It cites challenges faced by the kingdom such as war in Yemen and tension with Iran, and ‘the continued deterioration of public and external balance sheets, the significantly wider than expected fiscal deficit in 2016 and continued doubts about the extent to which the government’s ambitious reform programme can be implemented’. We are taking profits – there are too many imponderables. 

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