The Signal and the Noise

In today’s politically charged international environment, one may be pardoned for missing out on a good chunk of what is happening. This level of political turmoil on a sustained level, has had the effect of sanitising our opinions. We have grown more passive day after day, to events that we would have previously considered as politically and by implication economically significant. The approach, of understanding the political direction will leave us entangled to a web leading in conflicting directions.

For this reason, we should for a moment throw out of the window the political logic and start distinguishing the signal from the noise. The signals, we should be looking for over the cacophony of noise are long term trends, and sustained changes in the base layers that define the economy, which are the state of the enterprise, the labour and the capital.

What we know for sure is that it has been ten years since the last global recession. By any measure, this run has consolidated itself as the longest bull run in recorded market history. By implication one would say that some form of market correction would be now due. However, one should take caution in subscribing to this view. One common trait which can be found in most recessions is some form of excess in the market. This may present itself in different ways, such as house prices, sovereign debt or currency, which then proceed to infect the rest of the economy.

Oppositely, the approach observed in the months leading to a recession of “this time it’s different” is a very dangerous path to take. When such sentiment takes hold of the market, there tends to be “piling up effect” which drives asset prices on an exponential trajectory in what is considered the “final sprint” before valuations burst. We do not see this kind of attitude in the market, despite the overall upward trajectory, which could be interpreted that there is still some steam in this Bull Run.

We need to understand that the current market conditions are unprecedented, in that, never in history have central banks played the central role in extending the life of this economic run. Whether or not the global economies recovered as a result of a con-joint global central bank effort, remains a wildly debated argument in academia, however, investors have by now learned not to underestimate the willingness of central banks to implement policies aimed at driving economic growth, and in turn preventing downturns.

What we know for sure is that tools at the disposal of the central banks are now significantly less than they were before the recession overall, so in the coming future we can assume that the role of the central banks will remain strong, however, will be limited in the support they could provide. The reason why we can make this assertion is that central banks still have not stopped their asset purchasing programmes, which they always said they intend to wind down gradually.

It is important to be able to draw informed conclusions from the market data in order to be able to make a sound judgement regarding an investor’s portfolio allocation. What the current market signals are telling us can be summed up as mixed signals. On one side, many investors are overly cautious as a result of the high uncertainty regarding global growth and potential further deterioration of the political tensions. What this does is create a concentration into high quality assets. This can be attested through the fact that negative yielding debt until the end of August was in excess of $17 trillion dollars. This represents an increase of 105% in negative yielding debt compounding how strong this sentiment is amongst investors globally.

What this tells us is that investors, despite the current conditions, are unwilling to take further risks in pursuit of excess returns. Yet the current economic setup is designed to encourage these investors to do just that. This means that regardless of what the policy makers do, investors are not convinced in taking additional risk.

Manufacturing is another important signal that can help us make inferences on global growth. Through the Purchasing Mangers’ Index (PMI) – a measure of the aggregate increase or decrease in manufacturing month over month – we get to see whether global consumption is expected to increase or not. Since December 2017, the global aggregate PMI has been trending lower. This indicates a steady decrease in the rate of increase of global production. However since last May, this index has entered into contraction region which tells us that, global manufacturing has now turned negative, meaning that global demand is decreasing.

Additionally, this tells us that both consumers and investors are cautious of taking excessive risk. Their fears can be traced, from the uncertainty going ahead. Both corporations and consumers are unsure of potential regulatory shocks and the fear of being burned by another recession, to which their response is to postpone capital spending and investing.

After having understood the signals from the noises, the investors still need to have an important piece in order to complete their puzzle. The final piece is the strategy. The obvious reaction to these signals tend to be investing in a more cautious manner. However, many could miss out on market opportunities, in selected sectors and oversold markets (such as emerging markets) which could be long term investment opportunities trading below their fundamental value. Through the right allocation weightings, investors can shield their portfolio from eventual potential downturns, yet add some risk values to capture alpha in the future.


Daniel Gauci HnD Management, CeFa Investments, is an Investment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]