Kaletsky and Gave: bullish investors are ignorant of triple threat

by Sarah Miloudi on Mar 29, 2011 at 00:01

Investors are failing to protect against key risks that could rock the market, economists Anatole Kaletsky and Charles Gave have warned.

A clash between policymakers in the US and Europe, further hikes in the oil price and a default by either Ireland or Portugal could all hurt the market.  However GaveKal fears investors view this trio of threats as too obvious not to be priced in to the market.

‘Any one of these risks would be sufficient, on past experience, to trigger a full-scale bear market or at least a major correction in risk assets of all kinds,’ Kaletsky and Gave explained.  ‘Yet markets continue to climb a wall of worry, with investors assuming the huge risks facing the market do not matter.  Another surge in the oil price, a clash between the Fed and ECB or a default in Europe are all so obvious they must, by definition, be discounted in market prices.’

History has proved, however, that repeated jumps in the oil price can trigger a global recession.

The oil price has risen more than 60% since last August and is up roughly three times on its 2009 low. Moreover, on each of the five occasions since 1973 when oil has surged in value a universal recession has been triggered as a result.

But Kaletsky and Gave said that in a string of recent client meetings investors have been resoundingly bullish, despite  the extreme risks threatening to hurt markets.

Rather than considering when to sell the rally, investors are looking for signals to buy the dip, the pair said.  ‘The universally bullish pushback we have encountered in our meetings makes us uneasy, although we have never believed in contrarian thinking for its own sake,’ Kaletsky and Gave explained in their Five Corners investors’ update.

‘Can we truly believe markets would shrug off a $150 or $200 oil price?  Or war between Saudi Arabia and Iran?  Or a collapse in the dollar if the Fed moved to QE3 whiles the ECB tightened?  Or a default by Ireland or Portugal, triggering a bank-run in Spain?  While none of these extreme events is very likely, they cannot be dismissed out of hand.’

Investors can buy cheap insurance using VIX

In response to these high-impact tail risks, Kaletsky and Gave believe investors should look towards the VIX, which is now 20% lower than it was last August, when oil was priced $70 per barrel, versus $104 today. 

‘This means that buying out-of-the-money puts is still cheap,’ the duo explained, pointing out that although a plethora of hedges are available to investors the simplest strategies prove effective.

For investors unwilling to dilute performance by paying for insurance, collars could be an alternative.  ‘A collar of buying puts at 15% below the market and selling calls at 7% above costs next to nothing,’ Kaletsky and Gave pointed out.

Source: http://www.citywire.co.uk/wealth-manager/kaletsky-and-gave-bullish-investors-are-ignorant-of-triple-threat/a482179?re=13591&ea=264984&utm_source=BulkEmail_WM_Daily&utm_medium=BulkEmail_WM_Daily&utm_campaign=BulkEmail_WM_Daily

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