Today’s market continues to focus more on headline-making events that are not necessarily material to the investment landscape, while ignoring important geopolitical implications. This is much like trying to draw a map around the ripples instead of the waves on the ocean. A key tenant of our investment process tries to discern these “ripple”-like events from significant “wave”-like geopolitical events.
Underpinning these ripples and waves, are tides. Fundamental value is like the gravitational pull of the moon on the tide in that fundamental value inexorably pulls price toward it over intermediate- and longer-term time horizons.
The first stage of our investment process identifies Where fundamental valuation opportunities exist across the globe. Medium-term waves are geopolitical developments that affect market and currency prices. We leverage macro themes, game theoretical analysis, and a multi-dimensional assessment of conventional wisdom in the second stage of our process to determine Why prices are deviating from fundamental value, so we can navigate these waves.
We want to ride the tide, navigate the waves, and ignore the ripples.
The ripples are short-term issues that don’t rise to the level of macro themes or geopolitical game theaters—in essence they operate like noise. The vast majority of the time these ripples do not materially influence our strategy.
We want to ride the tide, navigate the waves, and ignore the ripples. Recently, we’ve been seeing plenty of ripples and, accordingly, we haven’t drastically changed our investment strategy.
In general, we continue to see roughly the same level of fundamental opportunities with fewer macro headwinds standing in the way of those opportunities as compared to a year ago and certainly fewer headwinds than were present two years ago.
U.S. equities are partially extended in valuation terms, but outside the U.S. (in Europe, for example) there is more potential for positive equity market performance—prices are still at a considerable discount to fundamental value across a number of markets.
Populism is waning. When measuring popular support coming from opinion polls for anti-establishment parties in the eurozone, such as France’s National Front, Italy’s Five Star Movement, Spain’s Unidos Podemos, and others, one can observe that support is still thawing from its peak at the start of 2017.
That’s clearing away a headwind, which provides more room for market and currency prices to revert to value. And financial institution and banking sector restructuring designed to resolve nonperforming debt is proceeding, albeit at a somewhat slow pace.
Again, as these events clear away hurdles to markets and sectors that we think are fundamentally attractive, these opportunities become more clear and potential places to allocate (additional) risk capital.
Recently, we’ve also seen a reduction in correlations between several emerging market currencies and equities. This is a positive development because it restores macro diversification benefits on which we depend while enhancing existing opportunities to be long across a number of emerging currency exposures. Higher correlations result in a narrower opportunity set and less opportunity for macro diversification.
The current currency opportunity is medium-sized in aggregate, but it’s also concentrated, which gives us some pause. The opportunity continues to be generally long emerging currencies—mostly in Asia—and short developed currencies.