August 2009 Issue: Key Points

This month we are launching a new format for our publications. Our objective is to make them more user-friendly for subscribers who would like easier access to the tables summarizing our analyses, while still providing the information that enables new subscribers to quickly get up to speed on our methodologies and views. We welcome your comments and suggestions.

Our economic update summarizes the continuing lack of significant progress towards resolving the three obstacles that stand in the way of a return to a normal regime of sustained economic growth: high levels of household debt across much of the Anglosphere, continued weaknesses in the financial system, and the inability or unwillingness of Asian countries, and China in particular, to reduce international imbalances by stimulating higher levels of personal consumption spending. As problems continue to build in these areas, and as the H1N1 influenza virus continues to evolve in a more deadly direction (based on the latest reports from Argentina and Brazil), we conclude that the market (as evidenced by rolling 3 month asset class returns) continues to underestimate the probability of a sharp increase in uncertainty over the next twelve months, despite the positive impact of continued fiscal and monetary stimulus.

This month's feature article is a letter to a recent university graduate, offering some important lessons that probably weren't taught in school. They include how to cope in an age of information overload, acknowledging the role of randomness (luck), how to make good decisions in the face of uncertainty, and how to have a fulfilling career in what promises to be a prolonged period of unpredictable change.

In this month’s AUD, CAD, CHF and GBP editions, we continue our analysis of risk/return regimes between 1991 and 2008, and the factors that drove asset class performance between 2006 and 2008. Across all four currencies, we find strong evidence for significant variation in asset class performance across the high volatility, high inflation and normal regimes. Our principal components analyses find that the 2007-2008 volatility/liquidity/solvency shock was the main driver of recent asset class performance. Over a longer period, we find that broadly similar factors drove asset class performance in these four regions, including changes in commodity prices, real interest rates, inflation expectations and real economic growth.

In our product and strategy notes, we take an extended look at the importance of speculative behavior in the determination of asset prices. We distinguish between trend following (buying winners) and momentum (a market neutral position where one is long recent winners and short recent losers). We conclude that there is a strong case for passive investing even when market prices are inefficient. We also examine recent "momentum" funds launched by AQR Capital in the United States. While there is growing interest in finding ways to invest in a "momentum index", we find that the AQR offerings are really trend following products that only invest in recent winners, rather than the market neutral uncorrelated alpha products that we would recommend for inclusion in investor portfolios. We suspect that, smart quants that they are, the product designers at AQR realized that high turnover and shorting costs would keep the actual results that could be earned by a true momentum fund well below the estimates that have appeared in many academic research papers.

| Global Asset Class Returns | Table: Asset Class Valuation Conclusions and 3 Month Return Momentum | Table: Market Implied Expectation of Most Likely Economic Regime | Uncorrelated Alpha Strategies Detail | August 2009 Economic Update | Feature Article: A Letter to the New Graduate | Global Asset Class Valuation Updates Detail | Product and Strategy Notes: Analysis Risk/Return AUD,CAD,CHF and GBP Based Investors; Trends, Momentum, Inefficient Markets' Argument for Index Investing, AQR Capital Products; Private Equity - Again and Four New Research Papers | This Month's Letters to the Editor: Country vs Industry Factors; Management of Client Expectations; Sold in 2007/08 What Now? | August 2009 Issue: Key Points |