Sunday Blotter - Thoughts on Q4: The Year-end Dash
The hedge fund industry has done a remarkable job at creating the perception that they are the smartest people in the room. This is not meant to be disparaging towards those many brilliant people who operating more speculative investment vehicles. Rather, it is an under appreciation to the level of sophistication that exists within the pension industry and the array of diverse investments they utilize. The level of complexity they engage in to achieve their long-term return objectives is impressive.
There is no right or wrong way to generate strong risk adjusted returns. We all get enamored with complicated strategies because they are intellectually stimulating but come December 31st, the only thing that matters is how much money you made versus the risk that you took. Nothing more. Nothing less.
For years now, speculative investors, in the aggregate, have performed strongly in the final quarter of the year. Despite the legacy superstitions surrounding the 1987 stock market crash, risk assets have tended to rally aggressively between early October and Thanksgiving. Seasonality can often be self-fulfilling but it doesn’t change the end result, that many trading oriented firms have historically generated a healthy percentage of their annual returns in Q4. I have been witnessing this for long enough to have faith in my observations.
The financial media and analysts will create narratives around this price action. While the likely headlines of potential tax reform, a smooth Chinese political transition, solid global growth and a more confident Fed will be the excuses, the fact remains that these are probably nothing more than tailwinds to assets that would have probably appreciated any way. I am not saying that the market will defy fundamentals. I am making the point that assets won’t have to. Despite some likely negative headlines regarding North Korea, growing pressure on Facebook regarding the Russian investigation and rising tensions within the UK Government over Brexit, there is just no incentive to fight the historical precedence of strong Q4 returns.
US economic data remains tarnished due to the impacts of Hurricane Harvey and Irma so a weak payroll number later in the week will largely be ignored. Pundits will continue to speculate on the chances of Kevin Warsh becoming the next Chair of the Federal Reserve and what this means for the trajectory of policy. It is interesting but it won’t be impactful. While rising interest rates will require an excuse, it will be the bounce in global equities and the risk on environment that will be the true reason why US 10-year yields will head back towards 2.50% over the next six weeks or so.
Japanese equities will outperform and ignore the upcoming election that should see Prime Minister Abe returned, despite a series of missteps. Pressure on the pound to grow as Boris Johnson continues to pester Theresa May over Brexit strategy. EM remains a big question mark and strong fundamentals could be overshadowed by higher USD funding and a rising USD. EM to underperform but I would not expect significant weakness.