Market Comment 1 February 2012

Notwithstanding our concerns about the increased chances of a technical consolidation or a small correction this week, markets have continued to rise. The primary driver has been expectations of the long-awaited restructuring of Greek debt. Whilst this strong and steady market move is welcome, I am slightly concerned at its failure to consolidate more healthily, after all, as the saying goes: "what goes up also comes down."

The details of the Greek restructuring have been increasingly leaked to the press over the last few days. We are now expecting old bonds to be exchanged for 30yr bonds with a coupon of around 3.6% plus a GDP enhancement, so there would a bonus pay-off if the Greek economy performs better than currently expected.

At today's prices, then, it seems that the Greek restructuring should be full expected, and already accounted for in the market. When it is confirmed, markets might either take the chance to consolidate (for example if the impact on Greek banks is extreme), or continue to move up more slowly (the jump we previously expected is now probably in market prices).

The downside risk is that the market will see through the current European rescue steps and not give the economic union the benefit of the doubt. After all, the Euro Summit continued to focus on fiscal measures, which are negative for growth. Also, (bearing in mind all this austerity) it remains uncertain that even the Greek problem has been addressed with this restructuring, since the European loans and ECB holdings will not be restructured alongside private investor exposure.

So, the European problem is far from resolved, but we believe the ECB's ongoing liquidity campaign serves to reduce the chances of a dramatic collapse of short-term confidence. Hence, we continue to recommend using any declines as a chance to build exposure to risky assets.

In other news, the US Fed has remained a supportive force, which has been welcome news as we receive a mini-flow of less positive data there. Not only has the FOMC extended the period of near-zero interest rates, but in his press conference last week Chairman Ben Bernanke also expressed a readiness to further stimulate the economy unless he sees improvement in growth soon.

Meanwhile, China has reopened cautiously after New Year festivities. Emerging markets are the leading equity group year-to-date (up 11.2% versus 6.1% for Eurostoxx 50 and 4.4% for S&P 500). We remain positive on EM as an asset class, and on China and Brazil in particular. But, global equity markets remain correlated. If Europe or the US consolidates, EM will probably pause too.

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,

James