Global markets continued to fall off a cliff in the past days as faith in policymakers to find definitive solutions to the debt crises and to rejuvenate global growth plummeted. The MSCI World Index has fallen by more than 20% since peaking on 2-May. And just in the past week, the index plunged by more than 7%.
In rapid succession over the past two weeks, announcements by policymakers across the Atlantic to tackle the unemployment and growth issues in the US and the sovereign debt crisis in Europe have failed miserably to inspire confidence. US President Obama’s bold US$477 billion jobs plan announced on 8-Sep and the US$3 trillion deficit reduction announcement on 19-Sep did not change the US outlook much because investors remain unconvinced that his plans will be approved by Congress given the entrenched polar positions taken by the two political camps. In Europe, leaders seem to be only paying lip service to keeping Greece in the euro-zone while refusing to consider more drastic actions to enlarge the rescue fund or the issuance of euro-bonds. In fact, the proposed changes to add more flexibility to the European Financial Stability Fund (EFSF) have yet to be ratified by the individual countries.
To make matters worse, the Federal Reserve reminded us last week of what we knew but refused to acknowledge – that the Fed has run out of good ideas to stimulate the economy. The markets have been looking up to the Fed because they are independent and not bogged down by politics, and are thus able to act decisively when needed. Unfortunately, that bastion of hope took a beating last week when the markets promptly sold off after the Fed’s FOMC meeting. The Fed’s announcement to “twist” its balance sheet from shorter dated bonds to longer dated assets by US$400 billion was a dud. With long rates already at historic lows, another few tens of basis points lower would hardly change much of consumers or corporate behaviour. The new reality is that the Fed has no more real bullets and that “Operation Twist” is more a gesture than deliverance. That is why the markets tanked.
Clearly, the current market environment is still characterised by significant systemic and cascading economic risks. While we would like to be more constructive on the markets after such a hefty correction, we feel the balance of risks remains asymmetric at this point.
In our opinion, the sovereign debt crisis in Europe is the more immediate risk because it has the potential to roil the banking system and further threaten the already stalling global growth. There are many variables and flashpoints but a resolution to the Greek debt situation (i.e. haircut) in our opinion is a necessary first step for us to become more constructive. We would also want to see a sufficient firewall in the form of an enlarged rescue fund to prevent contagion to other European countries and the banking system. With mounting pressure from investors and from foreign counterparts, we should see a breakthrough in the coming weeks and a resolution likely before end of the year.
Even if we get a resolution and an orderly one, risk assets such as equities, commodities and high-risk debt still have a long wall to climb. Risk assets thrive on economic growth and it is quite clear that growth in this “new normal” of debt reduction and fiscal austerity will be low. And there is not much more policymakers can do to stimulate growth when governments do not have much means to spend and central banks do not have much room to reduce interest rates. In other words, any market rebound subsequent to a crisis resolution may not have very strong staying power.
There are many “what ifs”. What if we do get an elegant resolution in Europe soon and there is no double dip. Or what if we are wrong and a resolution to the debt crisis is not forthcoming, or we have a resolution but a messy one. The odds seem to suggest that the balance of risks is still asymmetrical at this stage. Hence, we continue to advocate caution. The equity exposure in the “conservative” and “balanced” profiles now stands at 15% and 30% respectively.
Our strategy to go East has not yielded much as Asian markets have been held hostage to external macro events notwithstanding their better fundamentals. In fact, Asian currencies and equities suffered their biggest weekly drop in three years as capital flowed out quickly last week. The limitations in terms of breadth and depth of Asian financial markets mean these markets can react violently to swings in capital flows. Although Asian and emerging markets are still our preferred investments, without a breakthrough in the debt crisis, these assets remain extremely vulnerable to external factors.
A rebound is still possible on oversold conditions. And valuations in certain markets are looking extremely attractive. However, the sustainability of such a rebound will be suspect as long as the situation in Europe remains status quo and the global fundamentals remain weak.
For those with a stronger risk appetite and longer term view, as always, incremental buying on major pullbacks may still be a sound strategy.
Lastly, the recent correction in gold presents attractive entry points for investors looking to add on to their portfolios. We expect the rush into USD as a safe haven would unwind at some point. First, it was gold, then yen and the Swiss franc. But with the Swiss and Japanese central banks stepping in to prevent further appreciation of their respective currencies, markets turn their attention to the USD. With all the quantitative easing and money printing in the developed economies, it wouldn’t be long before the music stops and the only chair left is reserved for gold.
No comments:
Post a Comment