Global equity markets continued to make progress this week, despite fairly mixed economic data and newsflow. Investors seemed quite willing to set aside the bad news, including the UK economy shrinking in the fourth quarter of 2011 and Portuguese bond yields pushed to new highs. As a result, FTSE 100 stayed comfortably above the 5,700 mark.

The UK’s painfully slow recovery from recession was thrown back into the spotlight this week as the Office for National Statistics announced that the economy contracted by 0.2% in the final quarter of 2011. Poor manufacturing numbers shouldered most of the blame, as falling demand for goods – both home and abroad – left output down by close to 1%. Bank of England governor Mervyn King suggested that the continued weak growth outlook meant that further asset purchases to help stimulate the economy (i.e. quantitative easing) was likely. We expect this will be announced at February’s Monetary Policy Committee meeting.

In Greece, the negotiations between the Greek government and private bond holders continued. Charles Dallara managing director of the Institute of International Finance was negotiating on behalf of private bond holders and has indicated that he is comfortable with the 50% bond value writedown (or haircut) currently on the negotiating table. The sticking point seems to be the yield that will be made available on the replacement bonds. Dallara would like to see them issued at a yield of 4%, but unsurprisingly the government is pushing for a lower rate. At the time of writing discussions are ongoing, but the longer the negotiations go on, the more anxious markets will be. Most market participants want the Greek tragedy to reach a resolution (even if that means Greece exiting from the Eurozone) as once this happens it should strongly boost the outlook on Europe’s overall debt problems.

Towards the end of the week, markets were boosted by an announcement from the US Federal Reserve that it was on a path to keep interest rates low and keep monetary policy supportive for “at least through to 2014”. After last week’s announcement that it would begin publishing its forecasts for future interest rate decisions and setting itself a new inflation objective of 2%, the Fed seems committed to offering markets much greater transparency than it has been known for historically. However, as Mervyn King would be able to point out, inflation forecasting is a difficult business, and the Fed risks losing credibility if the members of the Federal Open Market Committee continue to display such an alarming divergence of views, as was revealed this week.

Portfolio activity

We added two new funds into our Alternative Strategies Foundation Fund this week. Eclectica Absolute Macro is an absolute return ‘global macro’ fund with an established track record of generating uncorrelated positive returns across different asset classes. We also added Cazenove UK Absolute Target, another long/short fund which has recently been tempering its defensive bias and increasing exposure to more industrial, commodity and consumer cyclical risk. We’ve also been adding to some of our holdings that benefit during periods of higher volatility.

As multi managers, we closely monitor the positioning of our underlying fund managers. After all, their portfolio positioning has an integral part to play in the overall performance of our funds. During periods such as these we can see whether our underlying fund managers are taking on more risk and taking advantage of positive swings in sentiment, but without it requiring us to alter our overall asset allocation. The new funds we’ve added are positioned more aggressively than most of our current holdings, but their long/short status also gives us useful protection if sentiment starts to turn more negative.

Outlook

We’re still cautious on the outlook for equities at present, and although sentiment is currently upbeat, bond markets and commodity markets have so far conspicuously failed to join in, which suggests the current rally, driven on relatively low trading volumes, is a fragile one. Perhaps this rally has been driven by the introduction of the European Central Bank’s Long Term Refinancing Operations which has helped banks shore up their balance sheets. But we still think that LTRO, whilst making the potential collapse of the Eurozone much less likely, is little more than a temporary sticking plaster covering a deeper wound. Portugal’s problems this week came as a timely reminder that the Eurozone debt crisis is far from being resolved. Until we see some clearer signals, from the bond markets in particular, we think it sensible to only make incremental changes to our asset allocation, relying on our underlying fund managers to alter their positioning, rather than undertake a more substantial shift in our equity positioning from neutral to positive.