Is this the double dip?

David Crawford - 09 July 2010

For some time it has been hard to resolve the micro versus macro debate, i.e. company fortunes versus the wider economic context. The bulls point to current positive factors like the confidence of companies and the low valuations of many stocks. Meanwhile the bears point to an economic environment with fiscal austerity measures and leading economic indicators peaking. The bulls also point to the relatively low valuations of equities versus bonds and cash, whereas the bears point to evidence from 2007-2009 when such ‘cheapness' did not provide any support for future share price performance.

On the Octopus Absolute UK Equities fund, we take long and short positions in stocks in response to and in anticipation of market events. Previously we cut short positions in cyclical companies and those with international exposure as the economic and company data was not supportive of being short. We continually look to reposition the fund for optimal absolute performance and over the last month we have reinstated quite a few of these short positions. Overall, the fund is now relatively market neutral in mid and large stocks and we have a net long but reducing position in smaller companies.

The question is, have we timed this correctly and will we see the performance we expect from these short positions? In answer, there is evidence that current conditions are more favourable to short certain stocks. The spring rally was in many ways a classic top of the market period after one of the biggest and fastest rallies in stock market history. Some investors missed out completely while many others piled in to try and capture performance, with the result that the market became saturated.

There is also a more favourable backdrop to re-instate certain short positions. The wider macro environment is more negative, with government led austerity measures in the Western world which, when combined with high personal debt levels, makes a consumer led dip back into recession more likely. The emerging world is still growing but inflationary pressures have been building and these countries may soon suffer from a hangover after their huge fiscal binge.

The bulls cling on to the mantra that ‘the companies are doing well' but many investors will remember that if you had followed companies in the last downturn you would have lost a lot of money. My view is that management teams have a bullish bias and can only report on what they see thus they are a poor indicator.

Summing up, I think it is easier to make a short case for many stocks but it is not as strong as in 2007/08. So my view is that taking a relatively neutral stance, whilst keeping an open mind as to what may happen from here, is likely to be the best approach.