Tactical Analysis

Over relatively short periods, financial markets may remain significantly over or undervalued for a number of reasons. For instance, some investors may harbor unrealistic expectations about corporate profits or inflation; or accounting rules or investment regulations may distort investment portfolios, thereby causing lasting imbalances in financial markets. Indeed, many observers consider that bond markets are currently expensive because new regulations have led pension funds and insurance companies to acquire bonds rather than equities.

Whatever the underlying factors, lasting mispricings are an essential feature of financial markets. Thus, even if an asset is overvalued, its price will not necessarily decrease in the near future, say within days or months. From a tactical standpoint, the key issue is not to ascertain whether a particular asset is dear or cheap; it is, instead, to identify the factors which may affect its price in the short run.

Empirically, these factors are threefold:

  Economic surprises. Obviously, a large number of investors may rebalance their portfolios following unexpected news on economic indicators or on governments’ decisions. Such a rebalancing may affect asset prices. It is therefore key to identify as precisely as possible when market participants’ expectations could prove wrong.
  Structural flows. Barring economic surprises, long-term structural flows in financial markets may cause imbalances between the supply and demand for financial assets. For instance, a country with a sizeable trade account deficit has to cope with net sales of its currency on foreign exchange markets. These sales structurally weaken its currency even in the absence of any economic surprise.
  Positions. Finally, financial markets can witness more erratic movements, often dubbed as technical, in the absence of news, when many investors rebalance their portfolios. Therefore, caution is in order when most investors are over-invested in some assets as these assets could depreciate markedly following a portfolio rebalancing to a more neutral stance.

To build its tactical overlay, DPA Invest closely monitors these factors, often responsible for short-term price movements.