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Multi-manager View: Liquid asset

At a recent investment conference, one of the guest speakers made the controversial statement that the study of economics was dead and that investors should stop wasting their time with the subject.

He went on to say that it was far more useful to track the flow of money, given how big central bank and hedge fund traders are these days. To justify his argument, he cited how economists have consistently called the bond market wrong due to them ignoring Asian central banking buying.

MitonOptimal does not necessarily share his sentiments but we agree that in making asset allocation decisions, one does need to take cognisance of the flow of money. Merrill Lynch has one of the better liquidity indices because it is easy to understand and because it has tended to be quite predictive over the years. In analysing its indices, it is apparent that global liquidity has decelerated quite sharply in the last six months, which is not surprising given the following factors:

First, the US monetary base has experienced slower growth as the Fed has continued to raise rates. The growth in money supply of 3 per cent has been far less than the nominal growth rates in US GDP. Second, foreign central banks have not been transferring their USD reserves back to the Fed to the same extent that the US current account deficit is growing by. This can best be explained by rising oil prices, which have resulted in a lot of the world surplus dollars being funnelled into paying for ever rising commodities.

Reason aside, falling liquidity is not good news for commodities and Asian stocks markets, with there being a positive relationship between the two. Essentially, this is a warning sign that commodities and Asian stocks could be under pressure.

Liquidity indices have been useful to MitonOptimal in the past when we have bought US treasuries and they have helped us be overweight the dollar in the last eight months in our offshore fund range. However, liquidity indices have been wrong on comm-odities as they do not take into consideration the rise of China and India as the major drivers of the super-cycle that we believe is currently unfolding in commodities.

Whether it is the Holy Grail in investing is another thing altogether, for it is our cynical opinion that if liquidity could predict the future, no investment house would ever share their information with the marketplace.

Joanne Baynham is head of fundamental research at MitonOptimal


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