Monthly Strategy – January 2012
It keeps getting harder and harder to write this monthly strategy posts and I’m not getting any better…
The consensus with which I agree is that the Euro zone is heading into a recession. While the economic activity has somewhat improved over the last months in the U.S. I remain doubtful whether the U.S. can escape the recession when Europe enters one. The data coming from China doesn’t (jet) point to a hard landing. For the time being it looks like that the Chinese government is in control. The measures to contain inflation and raising real-estate prices are successful, while in the same time China is has taken early steps to increase domestic consumption and re-balance the economy. One should not disregard and keep close watch on soft data coming from China especially in real estate and commodity related industries which are not reflected in the official data and could be pointing to serious issues.
Economic Growth
Economic activity in the U.S. has slightly improved from depressed levels in the time of last update, but the economic issues in the rest of the world are a factor that could swiftly reignite recession fears. It’s hard to expect that during a pause in monetary stimulus and in a time when policy makers are disusing austerity and tax increases we will experience a self-sustained return to pre-crissis growth levels. The odds of additional large scale asset purchases conducted by the FED are high. An unsustainable budget deficit and rising debt level are also problems that are moving into the spotlight and will gain in importance.
Developed Europe way of solving peripheral Europe debt problems is causing only fear in the markets and has put the sole existence of the Euro into question. In absence of a credible fix of Greece debt problems (an orderly default) I can see a massive crash in the both economy and markets. Additionally, in contrast to U.S, European counties have taken more prudent route and have chosen to moderate their expansive fiscal and monetary policies and this will take it’s toll with lower and/or negative (than U.S.) economic growth.
Earthquake and tsunami stricken Japan deployed massive monetary stimulus. Rebuilding efforts will need massive financing which will mean more debt issuance. In the short term this will spur growth and revive the economy, but the consequences for the long term (Japan debt burden is already beyond anything labeled normal) could be dire…
We have no decoupling of emerging markets and their growth depends on developed world demand. Emerging markets are clearly two tiered. We have China as a global manufacturing power house and a massive commodity importer and on the other side rest of the Brasil and Russia which are big beneficiaries of China commodity expansion. So it all comes down to China.
China has successfully constrained inflation and raising real-estate prices. Economic growth has clearly slowed and Chinese authorities have now reversed monetary tightening. There are signs that China has taken initial steps to re-balance it’s economy by increasing domestic consumption and reducing it’s export and fixed asset investment dependency in generating growth. One should not disregard and keep close watch on soft data coming from China especially in real estate and commodity related industries which are not reflected in the official data and could be pointing to serious problems. So, I would be very careful on China.
To sum up: All kind of headwinds ahead of the global economy. If we have rising commodity prices coupled with expansive monetary policies spurring inflation and anemic economic growth the result is my new mid-term base scenario – stagflation.
Equities
Equity markets have shrugged off the possibility of a global recession and have started the year in pretty carefree mood.
FED future actions will be a major factor. Short term the risks are on the downside.
Bonds
I was right on the duration of “extended period formulation”. I expect FED will be successful in keeping the interest rates low for a time being.
It is possible that FED announces a new round of large scale asset purchases.
Further down the road, inflation is a big threat…. Longer term bonds and inflation do not go hand by hand.
Commodities
Potential inflation is a big generator in commodity investment flows with precious metals being the prime beneficiary.
Energy Commodities
Crude Oil – The slowing economic growth puts pressure on the demand side of the equation. There is push from the western countries to put an embargo on Iran crude oil exports. In my opinion this has no chance of succeeding because there will be always able to find willing buyers for discounted Iranian crude and this will only change the logistics of the world oil markets not the supply/demand balance. The risk is here on the downside.
U.S. natural gas – the fundamentals are disastrous, the price at 10 year low. Warm weather leaves no hope for improvement. Technically looks massively oversold. A difficult market.
Industrial Commodities
This is the weakest link in the commodity universe. I’m continuously puzzled by aluminium strength.
Copper – one of rare commodities with a deficit on supply side. On the other hand price is pressured by large (Chinese) stockpiles and financing schemes. Could blow up, but I would rather not short fundamentally sound market.
Agricultural Commodities
Apparently China has started to boost its inventory of agricultural commodities. This means long all the way.
Precious Metals
The gold price weakness comes from disruptions in the money markets (European banks unable to get USD funding). The money market issues were resolved (by means of establishing aditional central bank swap lines and ECB massive repo oparations) and it’s good time to think of gold.
Silver – the market is totally broken and players have lost faith. Always a good entry point.
Agricultural Commodities, Aluminium, Brasil, China, Copper, Crude Oil, EU, Euro, FED, Gold, Japan, Natural Gas, Quantitative Easing, Russia, Silver, U.S., U.S. Dollar