2014 was a lacklustre year for equites other than the Shanghai Composite and perhaps the S&P 500. The current year has started slowly with declines recorded by all but the Hang Seng and ASX indices –
Forecasting market performance (let alone direction) for any period is hazardous to say the least. What we can do is look at where current prices are compared to our estimates of fair values, and present the results of trading the difference (buy when fair value is above current price and sell when conversely) over the recent past.
The graph below shows that the major indices are currently all sitting below fair value, indicating that equity markets are reasonably well supported by fundamentals.
The undervaluation percentages indicate that the best value opportunities are in the Asia/Asia Pacific region, although there is also value in the CAC 40 and FTSE 100.
Over the recent past, trading based on the (under)/over valuation indicator would have been profitable as shown below. Although past performance cannot be used to predict future performance, the back testing results do provide a modicum of comfort that the fair value estimates have a place in an overall investing strategy mix.
Trading an equally-weighted portfolio will reduce volatility (as shown above) and provide a hedge against backtest repeatability risk.
We also note that trading pairs of indices, currencies and commodities based on the undervaluation indicator has back tested with highly attractive risk-adjusted returns.
Short term catalyst – US retail sales
US retail sales growth for December is due to be released at 13:30 GMT on Wednesday, January 14 with a consensus expectation of 0.0% change MOM. As can be seen below, the European markets and S&P 500 have reacted to surprises with regard to this statistic -
Our statistical analysis of past actuals vs consensus suggests that there is a very slight bias towards undershoot in the upcoming announcement.