Tuesday, January 17, 2012

>GREED & FEAR: Reformulated Outlook (CLSA)


Stock markets opened the New Year on a strong note despite the seemingly concerning news from the Strait of Hormuz. Still GREED & fear remains fundamentally cautious. This is also the view propagated in the new reformulated Asia Maxima quarterly which now includes Australia (see Asia Maxima – Pain suspended and extended, 1Q12). The past year ended to GREED &; fear in a kind of truce in the sense that investors were relieved to see the European Central Bank (ECB) make increasing efforts to ease the liquidity situation of European banks, which remain the epicentre of systemic risk globally. Yet, markets had not yet been given what they really wanted in order to celebrate the hoped-for end of the European crisis. That was,
unsterilised monetisation by the ECB and fiscal union.

The result for GREED & fear is that the fault line which has been the cause of the European crisis, itself a nasty mixture of both sovereign debt crisis and banking crisis, still festers. That is, of course, the unsustainable combination of monetary union without fiscal union. So long as this is the case, there remains the likelihood of more euro-tremors and potentially a “euroquake”, to which risk assets globally will continue to be correlated. As a result, this crisis continues to exacerbate the debt deflationary dynamic which has been in play in the Western world since the so-called “global financial crisis” hit in 2008. In truth, of course, the crisis has never really ended with the symptom of that continuing deflationary dynamic the continuing Japanese style correlation of American or German bank stocks with long-term government bond yields (see Figure 1). Thus, the correlation between the German banks index and the 10- year bund yield is 0.96 since the start of 2011.

Still if this is the “big picture”, the New Year begins again with the focus very much on Europe. The issue facing investors is that markets have become used in the last 20 years to celebrating moral hazard-intensifying bailout trades, with most of these policies hailing from Washington. On this occasion, investors have had to contend with German psychology. This provided an abrupt wake-up call for markets in 2011. The first point is that the German political establishment does not like to make policy in response to immediate market pressures. The
second point is that the Germans do not easily accept that a debt problem can be solved by
simply adding more debt, most particularly if it involves the central bank “printing money”.

To read the full report: GREED & FEAR