Monthly Archives: December 2011

Market Comment 28 December 2011

As is traditional, markets are quiet with very low volumes as we approach the end of the year. This gives us a chance to reflect on where we are, how we got here and where we are going.

Regular market followers might be forgiven for being confused about year-end results, which find the S&P 500 and the DJIA Indexes closing the year flat or in positive territory, and most emerging markets indexes closing the year off by around 20%. In 2011, the global economy has grown by around 3.5%, in large part due to the stellar performances of emerging markets, yet investors have again suffered a dichotomy between fundamentals and performance. For its part, Europe has also suffered heavy losses, a performance that preceded the recession it is now experiencing.

The emerging world has suffered from two primary drags: First, being a victim of its own success (rapid growth led to inflation, requiring more restrictive economic policies, which are negative for equities). Second, moderate improvement of growth dynamics in the US, which also contributed to a shift in flows of investment capital.

Looking ahead for these markets, things are rosier now than of late, with most emerging nations already actively engaged in monetary policy easing, which should reignite growth dynamics, albeit less dramatically than occurred in 2009-10. Importantly, most emerging markets have kept their fiscal policies loose, reflecting a willingness to help rebalance international financial flows. We are positive for emerging market economic growth in 2011. Although our international Emerging Market Investment Committee remains neutral, there are healthy chances that it will upgrade in the first half of the year. Emerging market debt remains an appealing risk-reward asset class.

The performance of the US is less of a surprise to us. Whilst the market has remained trapped in an anachronistic expectations paradigm, with sentiment flipping between excessive optimism and fears of a recession, we have long argued that the US would struggle through with lower than historical growth, much as it did in the previous cycle. This trend is likely to continue in 2012, as fiscal tightening causes financial market stress, but we expect growth to remain positive. There will be scares and volatility, but 2012 may be remembered as the year that the US faced up to its long-term identity challenge, as the Republicans and Democrats square off with contrasting socioeconomic solutions for the longer-term.

Our global Investment Committee is neutral on US equities, in my personal opinion there is downside risk in the near-term, but this asset class is likely to end the coming year flat or positive. (The key risk being historically high margins, and the danger that corporate profits will eventually revert to mean.)

Europe remains the core question for all investors. The potential for stable or positive growth in both EM and the US (as discussed above) is fully dependent on the fate of the Euro Area; particularly on European politicians moving quickly in January to address the recessionary dynamic currently underway. Tough decisions to liberalise markets, sell-off assets and write down Greek debt are necessary. After three grandiose summits, rich on ideas, but followed by an implementation void, the market would do well to stop pre-supposing that Europe will act in its collective interest. Of course, a healthy dose of caution doesn’t mean we won’t see any progress. In 2012, we believe that Europe will eventually get itself onto a more sustainable path.

But, until that happens, we go into the year cautious and preferring short-term trading over longer-term investing.

May the New Year bring you peace and opportunity aplenty.

Best regards,


Market Comment 22 December 2011

Last week we noted that the foundations for a healthy 2012 are not yet in place, and that the jury is still out on the implications for sovereign bonds of the ECB’s decision to once again offer unlimited liquidity. Thus far, we don’t have conclusive progress on either point, but the trend is stable at the moment.

This week, Spain had a successful bond auction, and the first unlimited refinancing operation today has been met with high demand. The early indications are that the ECB has succeeded in restoring confidence, and that the banks will play along, using liquidity to reduce risk premiums. Whilst we welcome the risk-on nature of markets, particularly at these technically important levels, we would caution on excessive optimism. With Eurozone sovereigns needing to issue an almost €1.5 tln of debt next year, the jury will remain out for some time.

Unlimited liquidity may be enough to help reverse the credit freeze, a big plus to be sure, and possibly enough to help governments get their debt issuances done. But, unless there is a structural change in the European economy, it is unlikely to be enough to bring yields to sustainable levels, meaning that the debt crisis may continue to worsen, even if it does so away from the media spotlight. The current market dynamic is driven by monetary factors, but unfortunately political news is not presently moving forward as clearly as it was earlier in the year.

China is growing well, but more cautiously than in recent years. The US is currently performing well, in line with our predictions and better than many had expected. But unlike in the early noughties, it is not growing enough to pull the rest of the world up with it. Europe cannot expect another global macro free lunch, and needs to act decisively. Absent such assertive action, it is unlikely to experience an economic upswing sufficient to reverse the enormous economic damage caused by its reluctance to implement crisis response agreements.

For now, the market has a bit of a festive mood, and we welcome this. Technically and tactically, this rally might carry us through for several weeks, but it could turn at any time, and if the party goes on into January without reforms, it will quickly start smelling of excess.

Since the markets wait for no man (well, except perhaps a central bank head or two), we are working through the festive season. And so we will have a chance next week to wish you Happy New Year. But, Christmas itself is upon us. Enjoy it to the fullest.

Best regards,


Market Comment 15 December 2011

Much has happened since our last letter (OK, it’s the first letter I have posted here, contact me for the backlog!), not least the December meeting of the ECB and another European leadership summit. We became more nervous ahead of the latest round of crisis measures, reflecting that Europe can hold as many summits as it likes, but things may continue to worsen until it moves from discussion to implementation. Has anything changed?

The December summit led to stringent agreements on deficit management – a stricter incarnation of the Eurozone’s original Growth and Stability Pact (GSP). This move is concerning, first because it institutionalises austerity measures without leaving room for pro-growth solutions, second because this impractical characteristic means it is unlikely to sustain market confidence. Germany itself was the first to breach the deficit rules of the original GSP, a move that was understandable because it imposed excessively restrictive constraints. By introducing even less flexible rules, the EU is implementing a new economic statute, one which is guaranteed not to suit all countries at all times. There are some positives, such as using the European courts to adjudicate on areas of dispute, but the proposed system is likely to be rejected by more than just the UK before the discussion is over.

Meanwhile, the ECB has dramatically shifted gears, lowering rates another 25bp, and announcing new unlimited lending policies, of the form that helped resolve the 2008 credit crunch. Sure enough, this money is beginning to work its way into the system already, as demonstrated by this week’s Spanish bond auction. And the euro has moved sharply downward, as expected.

The question is whether or not the 2008 remedy will work this time? And here the jury is out. At the margin, it may enable to banks to be more supportive of new government issuance. However, there is an open question of whether banks will follow the ECB’s lead and prop up the system again. Yes, this is profitable lending and European banks clearly need profits, but is it sustainable? Perhaps the Greek debt restructuring has taught them a degree of caution. Until there is an implemented crisis resolution plan, including measures to cut Greek debt to sustainable levels and help all troubled nations to move back to growth, Europe looks unlikely to shake off its troubles.

Following tradition, the market celebrated the December summit with a sharp sell-off. As we write, markets are back in the green though, and with some momentum. The ECB’s recent steps should significantly impact frozen credit markets (good for corporate bonds) and help peripheral sovereign debt to some extent. But December’s summit kicked the can down the road. Over the next days we will be watching to see if the festive rally can recover, but, even if it does, we still lack a solid foundation for 2012.

Best regards,