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The key call: GHC Capital Markets on the west and black swans

The key call: GHC Capital Markets on the west and black swans

GHC Capital Markets Ltd. CIO John Clarke expects them to outperform but says eurozone remains a possible ‘black swan.’

Can you outline the breakdown or percentage split of a typical medium risk portfolio at the firm?

We don’t have a typical medium risk portfolio but run a range from 1 (lowest) to 8 of risk graded, variable weight portfolios with pre-set minimum and maximum exposures to various asset categories designed to correspond with clients’ attitudes to and tolerance for risk. Our current Dynamic Strategic Asset Allocation (DSAA) weightings, which incorporate our expectations for financial markets over the next 12 months, for our risk grade 5 and 6 model portfolios are shown in the pie charts, right. 

How has asset allocation changed over the last three months?

We have been steadily raising our equity weightings in DSAA since the summer as valuations improved and we detected the first signs of an acceleration in the quantity of money. In December following strong gains, we trimmed our US weightings in favour of the UK, where valuations had become extreme.

What have been your latest allocation calls?

Our main call is that, despite the uncertainty in the eurozone, we expect equities to outperform most other asset categories in the year ahead, especially government bonds. That said, with inflation set to fall sharply this year, policy rates remaining close to zero for the foreseeable future and central banks likely to engage in more quantitative easing, we do not expect a sharp rise in yields.

Where are you seeing opportunities from a valuation perspective?

Most global equity markets are attractively priced at the moment, in absolute terms as well as relative to government bonds. The clearest example is the dividend yield ratio on the FTSE All Share index, which is now lower than it was in March 2009 when equities rallied strongly.

Similarly, the earnings yield ratios in the US, Germany and Japan are all at record lows. While Japan can perhaps be rationalised because of the persistence of deflationary conditions, with policy settings now unambiguously pro-growth, equity markets in the UK, US and Germany now look seriously undervalued.

What technical indicator are you watching?

I tend to focus more on medium-term fundamentals rather than technical analysis. However, I try to keep an eye on relative strength indicators to see if a market might be overbought or oversold in the short term.

What is your current gilt exposure and how do you expect this to change over the coming year?

Gilts do feature in our DSAA weightings up to and including risk grade 7, but these are held primarily from a risk perspective.

Where could a potential surprise on the upside come from?

A big surprise could be that economic growth, both in the US and the UK, is stronger than most commentators are currently expecting. Just as the persistent weakness of monetary growth in late 2010 suggested to us (unlike the consensus) that economic activity would not be strong enough for either the Fed or the MPC to tighten policy rates in 2011, so its comparative buoyancy since the middle of last year is hinting that the resumption of trend or even slightly stronger growth might not be far away.  

What do you view as the potential black swans for 2012?

The biggest risk for 2012 is that the weakness in bank lending continues to offset the boost to the money supply and nominal national income from QE. The eurozone has the potential to upset and, to this end, we have undertaken extensive scenario planning in an attempt to assess the risks. One possibility is that the region splits in two, which would not necessarily be a disaster providing we manage to avoid the devaluing currencies.

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