Volatility has increased since last week. Even though we considered reducing risk in our portfolios, we decided not to do so. We do not think it is the right time to take any actions.

We believe that the increase in the observed volatility could be explained by three main topics, some appear to be more psychological than others:  1-some assets have recovered very quickly and we have seen some profit taking, in particular people question how much more room for price appreciation there is if it is not accompanied by real economic growth; 2-the calendar effect, as we get closer to the end of the year, funds decide to take a more conservative approach and realize their gains by reducing risk; and, 3-there appears to be some signaling as to a possible shorter monetary stimuli and its consequence for liquidity.

It is a fact that some markets have recovered a lot and very quickly, in particular Asia and commodity markets. We maintain a positive outlook in these, but we will trade with a cautious bias in the upcoming weeks. We disagree with the general consensus that government intervention is extremely relevant for recovery. It is our thought that “normal” economies grow in a secular fashion. As part of the business cycle, sometimes there is a crisis that erodes confidence and as a consequence bad economic decisions are taken that exacerbate the crisis. It is under these circumstances that the government as the biggest economic agent in the economy should act as a leader and coordinate expectations. As a response, the government showed the way by issuing a set of measures to restart the economy. These measures do not provide sustained growth; otherwise they would be applied by all governments all the time.

In terms of the second theme, profit taking, it appears to have a psychological flavor. Nonetheless it has real implications in the markets. Given that last year was a bad year in terms of profitability for the majority of fund managers, it is a natural to see some risk aversion and risk reduction, or profit taking, this year. There is a real incentive to show positive returns, both from compensation schemes and track record. This phenomenon is very calendar driven; nothing has fundamentally changed in terms of asset valuations to warrant a change in our portfolios.

The last topic is the most important one, and it is related to the first theme. We are currently in a very low interest rates environment as a consequence of the liquidity injected by governments. Some might argue that we are now in a new bubble, the dollar carry trade. When and if the Fed might signal an increase in rates, many of the current trade positions will become obsolete and the dollar will strengthen. The potential end of the dollar-carry trade is a main topic in our discussions and we keep it on our radar screen. This afternoon the Fed will make announcements and we believe that they will say “no changes for now”. It is important to note that other countries have started to reduce the expansive monetary policies earlier than what the market expected. Therefore, this triggered a debate as to whether we are starting to observe a coordinated effort to reduce the liquidity. This change would have real implications for the markets. We observe changes in monetary policy in those countries that have recovered sooner. Those economies are seeing capital inflows and a consequent currency appreciation. We have positioned our portfolios for this outcome.

We believe that in the US and Europe, these reductions in liquidity will be moderate and marginal. It will most likely start with a gradual reduction of the facilities used since the crisis and not with a real change in rates. We are considering a portfolio rebalancing to take profits in those trades that have paid off well, such as Asia and commodities.

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